Emerging markets back on top

The market reaction to the recent EU summit has been cheerful and the euphoria was felt across the world including in emerging markets.

Recent emerging markets research by Barclays Capital, however, indicated that although “the tail risk events are fading [in emerging markets], they are by no means off the table.

“We maintain our cautious stance and would not chase the rally. We are concerned that in Europe, implementation fatigue may surprise a market that has already priced in a very positive outlook.”

Newspaper headlines about emerging markets have been less than favorable of late, but that appears to have only made advocates of these economies more determined in their support.

David Kunselman, lead portfolio manager, Excel Investment Counsel Inc., left no negative views unchallenged at a recent conference call.

“We believe the trend of outperformance for emerging markets will continue this decade,” he said.

Rapid urbanization, demographic advantages, rising domestic consumption, GDP growth, infrastructure investments, healthy sovereign balance sheets; there wasn’t a card he didn’t pull out to substantiate that claim.

The decade that was

“When you look at historical returns this past decade, we find that a $10,000 investment in emerging markets would be roughly worth $23,700 today, versus only $9,200 investment in developed markets during the same period,” said Kunselman.

While the developed world is not expected to have the same problems as it has over the past decade, austerity will hold them back, he added.

This can have an impact on Canadian investors, as we tend not to be well diversified. Canadians currently have over 60% of their portfolio invested in Canadian equities and Canadian bonds, in spite of the fact that Canada represents only 4% of the world’s stock market capitalization and only 2% of the world’s bond market.

“During the past decade this big risk has paid off, [but] this may not be the case into the future,” he said. Investors take substantial risk investing only in one country. Canadian investors need to think globally to become more diversified.”

Emerging market equities, he said, outperformed both Canadian equities during this past decade as well as developed markets that were flat.

Personal income and spending of middle class

Today Asia Pacific countries represent only 23% of global middle class spending, but that is projected to grow rapidly to 59% by 2030, mainly due to China and India.

“By 2020 the world’s middle class will amount to 52% of the global population, up from 30% today; by 2025 China will have world’s largest middle class while India’s will be 10 times larger than today.”

Debt to GDP

Emerging markets average roughly 37% debt-to-GDP compared to almost 100%— andin some cases, more—for developed markets today, said Kunselman. The ratio for emerging markets was 50% just a decade ago, suggesting they more fiscal prudence.

“EM countries should also experience more debt upgrades versus the developed world which has experienced downgrades the past few years,” he said.

Credit Suisse estimates that government spending in the developed world is $8 trillion above the normal trend; taxes must eventually rise and spending down to get balance sheets back in order.

“This will take an entire decade to solve and in the meantime emerging markets will not share this debt burden.”

While developed markets have spent their fiscal spending ability or monetary stimulus, emerging economies still have both tools at their disposal.

Growth forecast

The combined growth of all emerging markets is pegged at 6%, the U.S. and the Eurozone, by contrast, are expected to grow at 2% and 1% respectively.

“The takeaway here is that the companies operating within EMs will have tailwinds and, therefore, investors should consider investing in these considerably faster growing markets.”

A recent Reuters survey of 30 economists showed all expected growth of 8% in the next year for China as a worst-case scenario.

“The important point is that the high growth can rapidly compound and we want investors to participate in this future compounding from emerging markets,” Kunselman said.

Low debt now, high spending later

The BRIC nations have very low household debt after years of saving. These countries are now beginning to use credit cards and taking out consumer loans. BRIC household debt is currently under 20% of GDP, compared to 75% or more in the developed world.

“This helps outline the rising consumption that can take place for the developing markets in the years to come as their middle class evolves,” said Kunselman.

Finally, there are some other simple facts to consider. “Emerging markets represent over 75% of the world’s landmass, more than 70% of the world’s foreign exchange reserves, 80% of the world’s population and a third of the world’s GDP and growing, [and yet] they have only 13% of the world’s market capitalization.”