Look­ing for Signs of Re­vival in ‘Slow­ing’ Emerg­ing Mar­kets

Since Jan 20, shares of cos based in rapidly grow­ing economies like Brazil, the Philip­pines and Thai­land have soared over 20%, dou­ble the gains of S&P’s 500-stock in­dex

The Economic Times - - Companies -

Paul J Lim

New York: For years, many in­vestors have been pin­ing for a re­bound in emerg­ing-mar­ket stocks, only to be frus­trated by the slide in com­mod­ity prices, which still drive many de­vel­op­ing economies. The sit­u­a­tion ap­peared to im­prove in the first quar­ter.

Af­ter sur­viv­ing another scare in Jan­uary, crude oil prices re­bounded about 40%, pulling up other com­modi­ties and emerg­ing-mar­ket eq­ui­ties. Since Jan­uary 20, shares of com­pa­nies based in rapidly grow­ing economies like Brazil, the Philip­pines and Thai­land have soared more than 20%, dou­ble the gains of the Stan­dard & Poor’s 500-stock in­dex of do­mes­tic eq­ui­ties dur­ing that time.

Is the bear mar­ket in com­modi­ties and emerg­ing-mar­ket stocks com­ing to an end? Not quite. Most econ­o­mists say it could take years be­fore a com­mod­ity “su­per­cy­cle,” like the one that drove emerg­ing-mar­ket stocks in the early 2000s, kicks in. Even if China, the world’s big­gest con­sumer of in­dus­trial com­modi­ties, were to re­gain mo­men­tum — a big if — the global econ­omy would still re­quire years to work through ex­cess ca­pac­ity, many mar­ket strate­gists say.

Although com­modi­ties con­tinue to be a drag, there are signs of sub­tle changes that make emerg­ing-mar­ket stocks more ap­peal­ing — at least more so than a year ago. “Com­ing into the year, there was this at­ti­tude: ‘Why take on ad­di­tional volatil­ity with emerg­ing-mar­ket stocks when you can get bet­ter re­turns for less volatil­ity in the de­vel­oped world?'” said Lau­rence Tay­lor, a port­fo­lio spe­cial­ist who works with global eq­ui­ties at T. Rowe Price.

As it turned out, con­cerns about the slow­ing econ­omy hit the de­vel­oped mar­kets harder than the de­vel­op­ing world, as Euro­pean stock funds lost 3.4% in the quar­ter ver­sus a 4% av­er­age gain for di­ver­si­fied emerg­ing mar­ket funds.

“That, per­haps, would be a cat­a­lyst for peo­ple to re­assess their emerg­ing-world the­sis,” Tay­lor said.

So too would the sur­pris­ing ad­vances seen in many of the most wor­ri­some economies — the frag­ile five na­tions of Turkey, In­dia, In­done­sia, South Africa and Brazil — which have im­proved their bud­get deficits, bal­ance of trade and in­fla­tion out­look, he added.

And the Federal Re­serve’s less ag­gres­sive stance on in­ter­est rates this year may re­duce a ma­jor head­wind for the emerg­ing mar­kets. At the end of last year, ex­pec­ta­tions were that the Fed would lift short-term in­ter­est rates four times in 2016, even as cen­tral banks abroad were still try­ing to stim­u­late growth.

Be­cause higher rates curb risk-tak­ing and strengthen the dol­lar, this was ex­pected to have a neg­a­tive ef­fect on emerg­ing­mar­ket shares.

Yet the Fed chose not to lift rates at its March meet­ing. And given the cen­tral bank’s more con­ser­va­tive ex­pec­ta­tions for eco­nomic growth this year, Fed of­fici- als are hint­ing that rates will be in­creased only two times this year. “The change in tone rep­re­sents more syn­chronic­ity with cen­tral banks in Ja­pan, Europe and around the world,” said Michael Kass, man­ager of the Baron Emerg­ing Mar­kets fund. That could rep­re­sent an op­por­tu­nity in the de­vel­op­ing world, money man­agers say, although this risky asset would merit cau­tion.

Even as­sum­ing that emerg­ing-mar­ket stocks will go back to be­ing one of the best-per­form­ing asset classes, as was the case a decade ago, the coun­tries that led the past rally might not lead a resur­gence.

Con­sider that the BRIC coun­tries — Brazil, Rus­sia, In­dia and China, which dom­i­nated emerg­ing mar­ket funds a decade ago — gained more than 770% from 1999 through 2007. That’s more than dou­ble the re­turns for other emerg­ing-mar­ket stocks. Yet since the fi­nan­cial crisis of 2008, BRIC stocks have lost a third of their value while the rest of the emerg­ing mar­kets have held their ground.

Then there is a val­u­a­tion prob­lem. “You can put emerg­ing-mar­kets stocks into a cou­ple of buck­ets,” said Jonas M. Krum­plys, co-man­ager of the Ivy Emerg­ing Mar­kets Equity fund. In one bucket are the com­mod­ity-driven economies of Latin Amer­ica and Rus­sia. In the other bucket are stocks based in economies that are in­creas­ingly be­ing driven by do­mes­tic growth and ris­ing con­sumer spend­ing.

This in­cludes mar­kets like In­dia, In­done­sia, Mex­ico and the Philip­pines.

The prob­lem is, stocks in the lat­ter bucket — which in­vestors fa­vor — are trad­ing at price-to-earn­ings ra­tios that are typ­i­cally 50% or greater than shares based in the com­mod­ity bucket. “In the ag­gre­gate, the emerg­ing mar­kets look cheap rel­a­tive to his­tory,” said Scott Craw­shaw, co-man­ager of the Hard­ing Lo­evner Emerg­ing Mar­kets Port­fo­lio fund. “But higher-qual­ity ar­eas of the mar­ket are trad­ing at very dif­fer­ent val­u­a­tions that are more caught up in the com­modi­ties down­draft.”

—New York Times News Ser­vice

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