But the actual notion of emerging or developed markets is less and less relevant. We are now moving towards an approach which ranks countries in terms of investment potential, a positive development stemming from the debate over government debt.
Are emerging markets managing to outperform?
Outperformance has in the past been engendered by high earnings growth, driven by the largest emerging market economies. However, markets in both the emerging and developed zones have been hard hit in recent weeks. In fact, the correction had already started several months ago in emerging countries due to inflationary tensions which surfaced at the end of 2010.
The recent loss of confidence in developed countries over sovereign debt in Europe and the US then triggered a further leg down. Some sectors were clearly overvalued but others were, and still are, undervalued. Today, it is important to note that emerging country risk has fallen sharply, especially due to more robust currencies and reduced volatility, and valuations are still attractive compared to developed countries.
Furthermore, given the fact that average debt levels are less than those in developed markets, estimated GDP growth rates are three times higher than those of developed countries. Also, dependency on exports to the Western World has been reduced significantly as other sectors such as local consumption, finance or infrastructure have been developing faster in recent years.
Growth and the selection process
If we take an objective look at emerging countries as a whole, many companies boast earnings growth and return on equity that are higher than in developed zone companies.There are several reasons for this. Strong growth and company cost structures - social charges, rents and corporation tax rates are often more advantageous than in developed countries - are the key factors.
Which themes to focus on
According to Thomas Gerhardt, Head of Emerging Markets and Commodities, emerging markets do not seem to be a homogeneous group of countries. It would be quite the opposite as there are two types of emerging country. On the one hand, there are export countries like Korea, Taiwan, Malaysia and Mexico which depend on Western countries; and on the other countries like India, Indonesia and Vietnam which can be described as autonomous. So there are significant structural differences within the emerging zone itself.
Overall, emerging markets are less and less dependent on developed countries as trade and cooperation between emerging countries has risen sharply. Africa and China are excellent examples: China is now the largest investor in the African continent.
Given the very important role played by China in developed and emerging countries, we should bear in mind that the Chinese equity market has suffered a sharp correction over the last twelve months due to inflation fears. However, given the fact that China’s central bank reacted positively to curb this trend by increasing minimum reserve requirements and raising interest rates, inflationary pressure has started to wane. When inflation peaks, China could be the first to recover.
Original press release from Edmond de Rothschild Asset Management