Emerging markets stocks have taken a beating in recent weeks as the credit crisis drags on.
In the past month, MSCI’s Turkey index dropped 20.45 per cent, South Africa fell 7.9 per cent, China lost 12.18 per cent, and India 12.7 per cent.
The scale of the downturn has called into question the theory of “decoupling” or “delinking”, which asserts that certain economies are able to operate independently of the US and so are immune from a recession.
“I’m afraid the answer is we don’t think emerging markets can decouple on a short-term basis,” says Jeff Chowdhry, head of emerging equities at F&C. “If you look at the first quarter, all markets have gone down and emerging markets have fully participated.”
Jonathan Compton, managing director at Bedlam Asset Management, is in agreement. “Decoupling is a myth because capital can flow where it likes and manufacturing can as well,” he argues. “So, if there’s an upset in one part of the world, it affects all the other markets. From Burkina Faso to Bangladesh, the world is more synchronised now than it was in its history.”
Even so, optimistic analysts still support the view that while decoupling is not in evidence in stock markets, there is some truth to it at an economic level – as Latin American and Middle Eastern countries now generate more growth from domestic demand and trade more among themselves.
Allan Conway, head of emerging markets equities at Schroders, claims the fall in share prices is not due to the subprime crisis but to sentiment.
Many investors who have seen strong returns from emerging markets in the past seven years are opting to take their windfalls now. In the past 10 weeks, emerging markets have seen outflows of $23bn, according to Conway – a startling sum, when one considers emerging markets saw inflows of $54bn in 2007.
“Emerging markets is the first place investors are going to lock in their profits,” Conway says.
So, if doom and gloom is as evident in China, India and Turkey as it is in the UK and the US – should investors continue to turn to emerging markets for some safety?
Chowdhry says yes, as he believes emerging markets will outperform in the medium to long-term.
“I would expect emerging markets to grow at double the rate of world economies because of the growth in domestic demand from consumers,” he says.
Compton of Bedlam, meanwhile, says investors should perhaps wait a bit longer before buying. “The bottom of the US cycle is when you play emerging markets,” he says.
While managers are shying away from investing in more expensive markets such as China and India, there is still interest in Russia and Brazil as demand from domestic investors is strong in both markets and valuations are cheap.
Petrobras, the Brazilian oil producer, is trading at 10.4 times this year’s earnings, Brasil Telecom at 8.8 times earnings, and Banco do Brasil is trading at 9 times earnings. In Russia, Lukoil is trading at 7.8 times earnings, MMC Norilsk Nickel is trading at 7 times earnings, and Novolipetsk Steel trades at 10.2 times earnings. Chowdhry also likes Evras, the Russian steelmaker, which is trading at 13 times earnings, as it is benefiting from increasing demand for infrastructure across the country.
Schroder’s Conway supports buying into countries benefiting from the commodities boom. As well as Brazil and Russia, Chile and Argentina offer value – they are up 9.39 per cent and 6.92 per cent respectively in the past three months.
In addition, analysts agree that the Middle East looks increasingly prosperous as oil windfalls are now being used to diversify the economies of Kuwait, the United Arab Emirates and elsewhere. Chowdhry of F&C’s favoured stock picks in the region include Air Arabia – the “Ryanair” of the Middle East, which is forecasting earnings growth of 30 per cent this year. “When you are buying into the Middle East today, you are buying a lot more than oil exposure,” Conway says. “These countries provide protection and a strong fundamental economic story as they have strong reserves and undervalued currencies.”
The traditional definition of emerging markets is also widening as managers are starting to move beyond the Bric countries – Brazil, Russia, India and China – to in-vest in further flung parts of Africa and central Asia, such as Morocco, Pakistan and Vietnam. Even Iraq is now being targeted by hedge fund managers. And Godvig Capital Management’s Babylon Fund, which aims to profit from the rehabilitation of Iraq, is one of a growing band of “frontier funds” seeking returns in everything from North Korean sovereign debt to political change in Cuba.
The sticking point, however, is that frontier markets tend to be small and re-stricted.
“The issues in lesser developed emerging markets often stem from a lack of transparency and liquidity,” says Robert Mirsky, hedge funds advisory partner at Ernst & Young. “Efficient structuring of investments into these markets can be a challenge as tax laws in some emerging jurisdictions can run the gambit from murky to draconian.”
