Emerging Questions

14/01/2011 at 3:01 pm

2011 has begun nervously for markets. Shares are struggling to hold their ground, major bond markets have drifted lower and commodities are treading water too.

This morning’s policy tightening by the People’s Bank of China has added to worries that emerging economies, which have accounted for most of the world’s growth since the financial crisis, will put the brakes on that growth as they seek to contain inflation. There is already a belief in some quarters that the recent barnstorming performance of emerging markets has left them too highly valued. Could tighter money trigger an unwinding?

It has to be said that developing economies have dashed investors’ hopes repeatedly in the past. Latin America in the 80s; the fall of the Asian tigers in the 90s, then the Russian default – emerging market investment has been characterised by frenzied optimism followed by savage loss time, after time, after time. Has the moment now arrived for BRIC to hit the wall?

Let’s look at some facts.

According to Bloomberg, the p/e of the MSCI Emerging Market Index has averaged just under 17 since 1995. Over the last ten years (excluding the late 90s bubble), the average was 14. The level now is hardly out of line at 14.6, and arguably cheap on a longer term view. (It also looks cheap relative to a number of developed markets.)

Furthermore, monetary policy alone was not a good predictor of returns last year. In Brazil, the central bank’s target rate was hiked by a total of 2% and the stock market performed rather badly, with the MSCI Brazil Index up only 4%. In India, by contrast, the target rate went up 2% and the MSCI India Index up 15%.

Finally, the balance sheets of emerging economies look a lot sounder than those of most developed countries nowadays. Brazil’s budget deficit is smaller than Germany’s. Russia has more than twice as many international reserve assets as the eurozone. The spread of emerging market bond yields over their government benchmarks – a key market measure of sovereign risk – has collapsed from over 8.5% at the peak of the recent crisis to a mere 2.4% today.

In a nutshell, then, while prices have undeniably risen, emerging economies are fundamentally sound, their market valuations are not stretched, and policy tightening is an unreliable guide to performance. On that basis, further funk over the machinations of the PBoC would look to present more of an opportunity than a threat.

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