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Lesson 21
Emerging Markets
Read and translate the text and learn terms from the Essential Vocabulary.
Emerging Markets: Has Their Time Finally Come?
With the world poised at critical crossroads – between recession and growth, war and peace, optimism and pessimism – now seems to be a timely moment to reconsider the case for emerging markets. In 2003, emerging equity markets actually held their value more successfully than developed markets, with declines of considerably smaller magnitude than those seen in the U.S., Europe and developed Asia.
The term
During the longest U.S. bull market in history, emerging markets might better have been termed «submerging markets», declining 43% from 1994 to 2001, during a period when the S&P 500 index gained 130%. The disconnect between the potential of emerging markets and the actual returns of recent years has been extremely trying for investors, and many have decreased or eliminated their allocation to this asset class.
Despite the current sentiment, there is a strong case to be made that now is an ideal time for emerging markets investment. Like value investing renaissance in 2000 following the burst of the Internet bubble, market turning points are often uncomfortable, and even painful in the short term. It is important to remember that when the economic outlook and investor sentiment are at their worst, even a small turn of events toward the positive can be enough to re-ignite markets. Some observations suggest that emerging markets offer a compelling investment opportunity at present.
1. Historically Low Valuations
Valuation levels are extremely strong for the emerging markets asset class and even more so for active, risk-controlled emerging markets portfolios, which have a single-digit price-to-earnings ratio, with attractive earnings growth forecasts. Overall, the emerging markets are the most attractively valued equities available to investors.
The emerging markets asset class is now selling at historically low valuation levels as compared to similar assets in developed markets. Based on P/E, valuations are currently half those of developed markets, compared to an average of 0.75 over the past 15 years. Such compellingly strong fundamental value cannot be ignored.
2. Economic Triggers – Near Term
Of course, valuations alone will not ensure strong equity market returns if there is no improvement in the underlying economic climate. However, markets are discounting mechanisms and tend to rise in advance of actual economic recovery. Emerging markets have been one of the more responsive asset classes in discounting economic change. We saw this in Mexico in the mid-1990s, when the stock market recovered well in advance of the actual turnaround in the economy and currency.
While the prospective economic recovery in the developed markets is likely to be more drawn-out and less active in the early stages than in past recoveries, the emerging markets are likely to gain significantly from a discounting of world economic recovery. This could start within the next 6 to 12 months, based on historical precedent.
In addition, areas within the emerging markets are actually among the few pockets of potential strength in global growth. Ironically, some of the currently stronger economic growth prospects would be the former command-and-control economies of China, Russia and central Europe. Most of the developed economies appear to have uncertain prospects for next year, especially the U.S. and Japan. The emerging markets, in contrast, appear better poised to recover, having experienced the downturn earlier and in many cases more severely than their developed counterparts.
3. Market Volatility Change as a Spur to Outperformance
In addition, emerging markets have historically shown good performance when global equity market volatility has reached a peak and then declined. Global market volatilities have continued at a high level after their September peaks, but a reduction of uncertainty regarding world political and economic issues could be expected to reduce volatility levels – which would be beneficial to emerging markets based on past patterns.
4. Economic Triggers – Long Term
Beyond the near-term triggers, there are some long-term economic and political developments that may be quietly laying the foundation for a sustained period of better performance from these countries. These would include the world’s increased recognition of the strategic importance of developing nations, new models for economic development that stress free markets and individual initiative, and evidence that nations that followed now-discredited approaches to development (such as the old Asian economic model) are already striking out on new paths.
In the aftermath of the September 11 terrorist attacks on the United States, there is a heightened awareness of the importance of key emerging markets in global security. Recently, the U.S. has stepped up economic assistance to supporters in the war against terrorism, including Pakistan, Egypt and Turkey. It seems likely that a greater degree of political partnership with these nations could well translate into greater investor attention, stronger capital flows and positive market performance.
It is also likely that there will be broader support for emerging markets globally, as their pivotal role in the new world order emerges. Potential political and economic instability in the emerging markets could create havoc for the world economy. The recognition that lack of economic opportunity provides a fertile breeding ground for terrorism are expected to solidify global support for measures aimed at reducing instability in the world’s developing regions. Greater stability would have a positive effect on emerging markets, reducing the risk premium and boosting equity values. Even a focus on just the largest markets would likely boost the overall asset class, as