Download Emerging markets` structural growth story remains intact

2013
Emerging markets’ structural growth story remains intact
Dara White, Senior Portfolio Manager
The 2008 global financial crisis spurred a rapid response
from policymakers in emerging markets (EM) as swift and
large fiscal and monetary stimulus occurred from central
banks throughout the EM universe. With looser monetary
policy, credit boomed, consumer spending surged and
infrastructure projects pulled forward. As a result, with the
onset of 2011, we saw a return of domestic inflation and
deterioration in asset quality at many banks, particularly in
the larger EM countries such as China, Brazil and India.
Policymakers responded accordingly and tightened policy
across the EM universe throughout 2011, causing the
economies to slow considerably. This proved too large a
headwind for EM equity markets, which underperformed
versus developed markets in 2011.
The cycle slowly started to turn at the beginning of 2012
and policymakers once again loosened monetary policy,
albeit gradually. The magnitude of the easing, while
disappointing to some market observers, was intentional
as policymakers were wary to prevent a return of inflation
and asset quality concerns. In that regard they have been
successful; we have seen a slow stabilization in the major
EM economies without the return of inflation.
However, because growth has stabilized rather than
rebounded strongly, there are some who believe the
slowdown is more structural (long lasting) than cyclical
— we are not in that camp. We believe the structural
advantages for EMs are still intact. And, while the growth
rate may not return to what it was during the last decade,
it may very well be growth of higher quality, i.e., more
consumption-led growth driven by a strong sustainable
middle class, rather than growth driven by fixed asset
investment.
Moreover, it is important to remember that approximately
70% of the world’s incremental global growth is coming
from emerging markets — even with the big markets of
China and Brazil slowing down materially.
Competitive advantages are still in place
Emerging markets suffered through crisis after crisis from
the 1980s until the early 2000s. In the process of
recovering from these crises and attempting to set up a
system that would prevent them from recurring, many
countries imposed new regulations and fiscal disciplines
that have left them in a much healthier place today. And the
factors that launched them on their growth trajectory are still
in place today, including:
> A manufacturing cost advantage, although now perhaps
in different countries and certainly different industries.
> Healthy corporate balance sheets that allow EM
companies to take on greater capacity. Companies have
continued to de-lever after learning many of the painful
lessons of carrying too much debt. This is also true at
the government and household levels.
Exhibit 1: Government debt levels remain under control
Global emerging markets (GEM) government debt-to-GDP
60
EM demographics are also a very powerful driver of
economies and markets over time. Due to the long lead
times, demographics are actually very easy to analyze and
predict. Having a young, growing workforce certainly
increases the potential gross domestic product (GDP) of a
country. Overall demographics in emerging markets are
much healthier than in the developed world, which will
continue to act as a tailwind over time.
50
Exhibit 3: Healthy demographics are a plus for EMs
110
100
90
80
70
40
Developed vs. emerging economy working age population
Working age population (ages 15-64) as a % total population
(%)
100
80
60
40
20
Sources: Ned Davis Research
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012e
0
Developed economies
12/31/50 = 58.4%
2050
120
2045
140
2040
Exhibit 2: Corporate net debt-to-equity remains low
Emerging economies
12/31/50 = 63.7%
2035
The percentage of debt-to-GDP in non-Japan Asia and the global
emerging markets remains well below that of the United States
and other developed nations.
2030
Sources: Thomson Reuters, Credit Suisse research
Data as of 6/30/11
2025
U.S.
2020
Global emerging markets
Peaking later and then
declining at slower pace
2015
Non-Japan Asia
67.99
67.60
67.21
66.83
66.45
66.07
65.69
65.32
64.95
64.58
64.21
63.84
63.48
63.12
62.76
62.40
62.04
61.69
61.34
60.99
60.64
60.29
59.95
59.61
59.27
58.93
58.59
2010
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2005
30
2000
(%)
Demographic trends are another positive
Latin America
Asia
EMEA
Sources: USB GEM Inc., UBS World Inc.
Emerging market corporations have brought debt levels down
considerably in recent years, including those in Latin America
and Asia as well as Europe, Middle East and Africa (EMEA).
The working age population will peak much later in emerging
markets than in developed markets, and will subsequently
decline at a slower pace. A young, growing workforce increases
the economic growth potential of the region.
67.99
67.60
67.21
66.83
66.45
66.07
65.69
65.32
64.95
64.58
64.21
63.84
63.48
63.12
62.76
62.40
62.04
61.69
61.34
60.99
60.64
60.29
59.95
59.61
59.27
58.93
58.59
It is important to note that within EMs, there are stark
differences between countries that help guide our country
allocations. When a country has both a strong demographic
profile and an economy that allows for social mobility that
country can truly capture the demographic dividend.
In our 2012 Perspectives, we published “The demographic
winners and losers in emerging markets.” That story is
still relevant today. Our favored countries with good
demographics include Indonesia, the Philippines, Turkey and
Brazil. We also add India, where J.P. Morgan estimates that
250 million people will enter the working age population
between 2005 and 2025. This is a staggering number and
could turn out to be extremely powerful.
Headlining the losers in terms of demographics are the large
markets of Russia and China. The one child policy, in place
since the 1970s, has had a very serious impact on Chinese
demographics. It looks like the Chinese workforce will peak
sometime in the next few years in terms of sheer size.
The Chinese government is well aware of this phenomenon,
and perhaps that is one of the reasons they have dedicated
significant resources to improving education levels and
moving up the value chain. Other areas where we have
concerns about demographics are South Africa and parts of
the Middle East, where the populations are young but the
lack of social mobility caused by poor education and
structural unemployment may prove to be a recipe for
social unrest.
Addressing China
The macroeconomic data in China has stabilized and
continues to point to a soft landing. We don’t expect an
immediate change in policy with the new leadership in
China. We believe the new leaders, like the previous ones,
view the magnitude of the 2009 stimulus as a mistake and
many industries are still feeling the ensuing overcapacity.
We believe that employment remains the government’s
primary focus. As long as employment stays strong, we do
not expect another round of big stimulus, but rather a
continuation along a gradual transformation to a more
consumption-led economy.
At the same time, we do have some concern that China is
becoming less competitive, particularly on the low end of the
value chain. The cost of doing business has been rising
rapidly due to the peaking of the workforce and the steady
increase in wages, which has hurt the return on invested
capital of the export sector. Over the long term, we believe
they will be successful in moving up the value chain, but it
may be a bumpy transition due to weak demand, particularly
from the developed markets.
Our other concern on China has been the deterioration in
the return on invested capital and earnings of the listed
companies. Many sectors are in a state of overcapacity and
the earnings downgrades have felt much more like a hard
landing than the macro numbers indicate. Part of the
problem is that Chinese companies have historically
managed for maximum growth in output. Managing in a
constrained environment has been a new experience for
many management teams, and the stress is showing.
One silver lining is the housing market. Since the policy
restrictions were lifted last March there has been a
significant pickup in transaction volumes, hence inventories
have started to come down and new starts have begun to
pick up. The gains in investment will have a good effect on
the economy.
China is a complex market, and it is important to keep
in mind the positive and negative crosscurrents when
evaluating it. Our expectation from here is that the macro
numbers will muddle along as we continue to look for
opportunities at the individual stock level.
Beyond the BRIC
The emerging markets are not just about the big four
countries of Brazil, Russia, India and China. It is true that
all four have faced some type of cyclical or even structural
issue in the last 24 months, which has held back the
overall performance of the broader EM index. However, that
has masked the stellar performance of some of the smaller
index constituents. Through October 31, 2012, markets
such as the Philippines (up 36% in USD terms), Thailand
(up 25% in USD), Turkey (up 53.84% in USD), and Mexico
(up 21.94% in USD) have continued to post very strong
returns supported by solid fundamentals. Investing in
emerging markets requires the flexibility to position
around an often-inefficient index to take advantage of
these opportunities.
As of the end of October 2012, constituents of the energy,
financials and materials sector made up a little bit more
than 50% of the weight of the overall index. This is why the
index behaves in such a cyclical manner and does not truly
capture the secular opportunity associated with the EM
universe. Consumer and services sectors have been leading
the market’s performance over the past few years. Given the
secular trends with strong middle class formation in many of
these countries, we feel they should continue to do so. The
same point can be made on the stock level, where the top
end of the index is dominated by state-owned enterprises,
whose primary purpose is to provide employment for the
people of the nation rather than to maximize shareholder
value. Over time, a distinct focus on companies that create
shareholder value should also add to returns.
During this economic slowdown it has been hard to separate
the cyclical versus the secular issues, but the long-term
drivers for EM growth are still in place. Analysts have
consistently revised earnings estimates downward and
multiples have compressed. Expectations for emerging
market equities are low, but with the help of accommodative
monetary policy, growth seems to have stabilized. In the
current environment, one may need to dig a little deeper and
work a little harder to find great investment opportunities
— but they are there.
Investments in emerging markets present greater risk of loss than a typical foreign security investment. Because of the less developed markets and
economics and less mature governments and governmental institutions, the risks of investing in foreign securities can be intensified in the case of
investments in issuers organized, domiciled or doing business in emerging markets.
Important disclosures
The views expressed are as of January 2013, may change
as market or other conditions change, and may differ
from views expressed by other Columbia Management
Investment Advisers, LLC (CMIA) associates or affiliates.
Actual investments or investment decisions made by CMIA
and its affiliates, whether for its own account or on behalf
of clients, will not necessarily reflect the views expressed.
This information is not intended to provide investment
advice and does not account for individual investor
circumstances. Investment decisions should always be
made based on an investor’s specific financial needs,
objectives, goals, time horizon and risk tolerance. Asset
classes described may not be suitable for all investors.
Past performance does not guarantee future results and
no forecast should be considered a guarantee either.
Since economic and market conditions change frequently,
there can be no assurance that the trends described here
will continue or that the forecasts are accurate.
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