As Sir John Templeton pointed out, it’s never really different this time.
This week’s developing world turmoil is familiar territory to anyone who showed an interest in financial markets in the 1990s. Emerging markets toppling like dominos as the “tourist dollar” packs its bags and catches the first flight home; America leading global markets higher as investors prefer the safety of the tried and tested over the blue-sky growth story; a strengthening US currency and falling commodity prices. We’ve been here before. It’s certainly gave the great and the good something to talk about in Davos. After several years in which the West has gathered in the snow to be reminded by its emerging-market guests of the shortcomings of its model, the home team has had the opportunity to wave a stick back again. Tiger economies When the Tiger economies were hunted down in 1997/8 they vowed never again to be dependent on the whims of foreign investors. They adopted an export-led model, built up their foreign reserves and developed home-grown bond markets to underpin the financing of their growth. But the job was only half completed and the easy exports into credit-crazy Western countries have evaporated as they rebuild our personal and corporate balance sheets. Meanwhile, the overseas inflow- habit was never really kicked but disguised while interest rates remained at emergency levels in the US. That is why last summer’s first hint that the monetary party was drawing to a close caused such upheaval in emerging markets and why, since the process actually kicked off in December, things have deteriorated so quickly. Retail investors seem to have picked up on the risks to emerging markets more quickly than their institutional counterparts. According to estimates, which monitors investment flows, individual investors pulled $US2.5 billion out of emerging markets in the week to last Wednesday. That was twice the outflow in the previous week and brings the total, in the year to date, to around $US6 billion. Emerging market bond funds have lost a further $US2 billion. It’s not been a blanket withdrawal from emerging markets. Investors have focused on those countries where an addiction to cheap money has been compounded by bad policy. Countries with yawning current-account deficits have seen currencies, stocks and bonds crumble. But, as ever when there is a rush to the exit, the most liquid markets have been clobbered even if they are not the worst offenders. A key determinant So how long will the rout go on? For equity investors a key determinant will be valuations, which after the decade-long rally since the bursting of the dot.com bubble no longer offer investors much compensation for the additional risks of investing in emerging markets. During that period, in which everyone trumpeted the shift in the world’s economic centre of gravity, stock-market investors forgot the old adage about emerging markets being those it is difficult to emerge from in an emergency. There are notable exceptions to this valuation parity. China and Korea, for example, trade on much cheaper multiples than their Western counterparts – single-digit price-to-earnings ratios are close to historic lows in these two countries, which is why I still view China as an interesting contrarian play in 2014 as the longer-term benefit of last November’s reform package starts to be better understood. But others in the Asean countries of south east Asia are valued on a par with the developed world. Investors are paying 14 or 15 times earnings in Hong Kong, Indonesia and Malaysia. In the Philippines, it’s more like 18 times. Exporting to safety These countries will benefit from a pick-up in the rich economies – they might once again be able to export their way to safety. But in the meantime they need to strengthen their financial systems and work to improve their competitiveness. It’s work on the roof that would have been easier a few years ago when the sun was shining than it will be now the emerging market storm is raging. My investment outlook for 2014 argues for developed markets to build further on 2013’s out-performance of the emerging world. Nothing that’s happened so far this year suggests my preference for the equity markets in the US, Japan and the UK will be wrong. Nor does it undermine my argument that the rotation out of bonds is likely to be deferred for a while yet – the slide in the yields offered by the safest government bonds this week shows that there’s still an appetite for safe havens.
30/01/2014
Tom Stevenson
Source: Professional Planner
www.professionalplanner.com.au
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