Is the tide turning for emerging markets? Slowly, according to Neptune’s chief investment officer and chief economist James Dowey. But even when fortunes change for the emerging economies, investors should be wary of expecting too much.
For history will not be repeating itself, according to Dowey. The 370% return of the BRIC nations in the Noughties – the decade from 2000 to 2010 – was a one-off phenomenon.
“In the decade from 2000, emerging markets blew the lights out, while developed markets recovered from the tech bubble bursting and slid towards the sub-prime disaster” explained Dowey. “That was one of only four decades in stock market history when the US failed to make a positive return – alongside the First World War, the Great Depression and the period of high inflation in the Seventies.”
Fast forward five years and the BRIC nations – Brazil, Russia, India and China have heavily underperformed developed markets.
“Their economies and politics are in disarray,” said Dowey. “Guessing their investment prospects from here? You have a very wide range of options.”
Dowey says that like the technology bubble of the Nineties and the housing market bubble the following decade the extreme rally of emerging markets in the Noughties was also an inflated market ready to burst.
This was propped up by warped fundamentals – investors quite literally believed the hype and this pushed markets higher than they should have grown.
Dowey said that there were misperceptions which inflated the emerging market bubble. The first was that emerging markets would easily emulate the technologies and industry evolution that developed markets had invented which propelled their economic growth. This was not true – supportive politics and education was required.
The second misperception was the effect of availability bias. During the emerging market rally no one talked about the failures – investor focus was on the four BRIC nations’ success. Even the acronym BRIC exacerbated the problem and launching funds with the term in their title added notoriety. This positive sentiment fuelled the rally, until it hit roadblock.
“It was assumed that emerging markets were on a trajectory to democracy which would have sustained growth. But there is nothing automatic about political reform,” said Dowey. “All of the BRICs have had corruption issues and struggled to change. India has a corrosive system prior to Prime Minister Modi, Brazil has corruption and the pressures against Russia are mounting.”
Emerging Markets vs Developed Markets: A Dead Heat
And so, in the years since 2010, developed markets have far outstripped emerging market equities. This pattern is one that has yo-yoed since 1900 – with five decades a piece of outperformance for each set of economies since the turn of the last century.
In the Nineties it was Fed tightening monetary policy which led to the Asian financial crisis, while in the 1940s confiscated Chinese and Japanese assets during the Second World War meant developed markets again outperformed.
Time for an Emerging Markets Recovery?
While Dowey stresses it is “imperceivable” that emerging markets repeat the performance of the 2000s – saying we have to be “highly cognitive of that” – he does think that the case for emerging markets is mounting.
“Emerging markets work best as a value play,” he says. “And at the moment currencies are attractively devalued and the stock markets look fair.”
There are two main threats to emerging markets’ performance; China and the Fed. But since the beginning of the year, both of these threats have abated according to Dowey.
“The Fed now takes China into account when deciding policy,” he said. “And China is working through its debt problem. We believe China has the tools to fix their problems.”
Euan Thompson, head of Emerging Markets for Neptune agreed that while emerging markets were a heterogeneous asset class they economies were linked by big macro trends – there are certain conditions which they do well in.
“The last five years there has been a lack of economic growth and a lack of earnings globally, which mean people pay higher premiums for growth stocks – they don’t want to take a risk on value investments,” he said. “Now, emerging markets look especially attractive when you look at the other options. Developed markets are expensive.”
Thompson said that India was his favoured market because it was the most “stable opportunity, the most protected market from the on/off commodity oscillation”. Thompson also likes companies in Indonesia, South Korea and even Russia because the valuations are compelling.
