Secular trends to remain EM growth driver


By Wouter Klijn

There are few more clear examples of how secular trends will determine the performance of markets than the current industrial and demographic developments in emerging markets.

To a degree, it is the law of large numbers, where further improvements in living standards and urbanisation will see a large slice of the world's population morph into discerning consumers, while industrialising nations are still catching up on their domestic infrastructure.

But recent concerns over the slowdown in China and the effect of low energy prices on commodity-dominated economies have made many investors bearish.

“The term emerging markets is a bit of a dirty word these days,” JP Morgan Funds chief Asia market strategist Tai Hui said at the PortfolioConstruction Forum's Markets Summit in Sydney on Tuesday.

“Most of what we hear about it is bad news.”

But much of the negativity surrounding emerging markets is the result of on one hand cyclical forces, while on the other hand it is the product of the relatively short investment horizons many investors adopt.

“There are risks and opportunities in the short term, but on a three to five-year horizon I'm more optimistic,” Hui said.

Like many speakers at the summit, he said the increasing influence of secular and structural trends would mean investors would have to be more selective in their investments.

“My key conviction is to have a broad diversification here,” he said.

“Investors ... need to clearly differentiate among the various emerging markets and pay more attention to country-specific conditions.”

Looking back at 2014, for example, he said the Indonesian stock market had performed well, but an investment in Russia would have lost money.

Although many investors were currently concerned about the impact of the weak oil price, he said he believed that also was not a negative for all emerging economies.

“The low oil price is a huge windfall to countries with oil subsidies,” he said.

“Cheap energy prices will benefit most, but not all emerging markets.”

India's promise

One of the more interesting countries among the emerging markets was India, according to speakers at the summit.

Hui said he was initially concerned about unrealistic expectations about the speed at which Prime Minister Narendra Modi could change the country.

“Wherever I went in India and expressed the opinion that reforms would take many years, I was lectured by management about why Modi would change things in a flash,” he said.

“Where we are now is that people are more realistic that this is a multi-year process. But people are optimistic that it is heading in the right direction.”

BlackRock head of Asian credit Neeraj Seth gave three reasons for optimism about the economic prospects of India: its current reform process, macroeconomic health and favourable demographic profile.

“India is facing one of the strongest demographic waves in its history and will add approximately 125 million people to the working-age population over the next 10 years,” Seth said.

“This is some 25 per cent of the estimated increase in global working-age population over the same period.”

Although India was initially categorised as one of the 'fragile five' after the US Federal Reserve announced it would cut back its quantitative easing program, the country has since become financially much healthier.

“India, unfortunately, was one of the founding members of the fragile five,” Seth said.

“It had a current account deficit of 4.7 per cent of gross domestic product (GDP) and there were concerns over how to fund that deficit.

“But now it is about 1 per cent of GDP.

“The incremental flows in onshore debt and equities are helping the Reserve Bank of India to strengthen foreign exchange reserves and build a war chest that can be used in a likely weaker global macro environment.”

He said there would be investment opportunities in Indian equities, foreign exchange and debt, but long-term investors should also look at the upcoming infrastructure projects.

“Infrastructure is at the centre of everything that the government is trying to do,” he said.

“We are talking about something like US$1 trillion in projects over the next five years.

“There will obviously be the banks and the local institutions, who will be putting money in, but I would argue there is enough of a gap that the government would focus on attracting foreign capital.

“This would be a phenomenal area for really long-term investors.”

He warned investors to be sensible, but not to be so conservative as to miss the boat.

“Transformations like this happen once in a lifetime,” he said.

“Be partial about your investments, be mindful about the risk and it is okay to be a sceptic, but don't completely miss it.”

Risks ahead

Yet, Standard Life Investments chief international economist Jeremy Lawson was less optimistic on the outlook for emerging markets.

Lawson argued the rapid economic growth in emerging markets prior to the global financial crisis was unlikely to return.

“The pre-crisis period of economic growth for emerging markets was actually highly unusual,” he said.

“There is sometimes the tendency to think that that period was the norm for emerging markets and that we can expect emerging markets to continue to converge on the developed economies at the pace that it did between 2003 and 2008.

“The point is, though, that that was a very anomalous period.”

Turkey, Brazil and Malaysia were the most vulnerable markets, while Russia also presented a precarious investment case, he said.

But he also said it was unlikely emerging markets were facing a crisis.

Based on a heat map of external, domestic and institutional indicators that helped predict past emerging market crises, Lawson concluded that, although there were pockets of significant risk, there was only a modest likelihood of a systemic emerging markets crisis that could threaten the global economy.

And with that he returned to a conclusion reached by many at the summit that selective, well-researched investments would be key to navigating through the upcoming period of heightened volatility.

“While we are not predicting a crisis, investors should be mindful of differentiating between countries when allocating capital to emerging markets,” he said.

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