by Mark Mobius

Stocks

Are Emerging Markets oversold?

Mark Mobius is an emerging markets fund manager at Franklin Templeton Investments
Mark Mobius.jpeg

During the past few months, emerging markets have been subject to such pessimism. These periods of short-term volatility are certainly not new to us, and don’t change our long-term conviction of the potential emerging markets hold.

I feel recent declines were overdone and based largely on irrational investor panic, and have viewed the recent pullback as an opportune time to search for bargains for our portfolios. We find valuations in many emerging and frontier stocks particularly attractive right now.

No doubt, emerging markets have been beaten up a bit this year. In the second quarter, the MSCI Emerging Markets Index lost 8.0% in US Dollar terms, and emerging markets recorded outflows of US$33 billion during the quarter; June alone accounted for US$22 billion of the flows. This offset the US$32 billion in net inflows from the first quarter of 2013, resulting in a net outflow of about US$1 billion for the first half of the year.

What happened? Indications in mid-May from US Federal Reserve Chairman Ben Bernanke about a moderation in the central bank’s asset purchase program caused fixed income investors who had invested in offshore bonds, particularly in emerging markets bonds, to view the high yields they were receiving in those bonds as less attractive if US interest rates were to rise.

In addition, signals from the People’s Bank of China that it would not intervene in the market after a sharp spike in a key interbank lending rate in June raised concerns about the stability of the banking sector there, and further heightened investor concerns that global liquidity could dry up. 

A sharp, across-the-board sell-off hit emerging market debt, currencies and equities during the second quarter. Those particular emerging market countries with high current account deficits, large foreign holdings of local bonds and exposure to China were among the worst affected. Turkey, Egypt and Brazil were particularly hard hit; their respective equity markets ended the quarter with declines. In addition, periods of social unrest in these countries also heightened investor anxiety.

The Case for Emerging Markets

I believe emerging markets in general have three attractive characteristics, which haven’t changed from what I see. First, their growth rates have generally remained well in excess of those for developed markets. Overall, emerging markets are forecast to grow about five times faster than developed markets in 2013, with the IMF forecasting average GDP growth of 5.0% for emerging markets, compared to just 1.2% for developed markets.

Second, emerging markets generally have large and growing foreign exchange reserves, which are far greater than that of developed markets. Moreover, unlike developed markets, many emerging and frontier markets still appear to have ample room for fiscal and monetary stimulus. 

Although weak growth in developed markets could be transmitted to emerging markets, notably through declines in world trade, this influence could continue to be offset in emerging markets by higher investment spending and increased domestic demand. Third, the debt level of many emerging markets in relation to their GDP is generally much lower than that of many developed markets.

Additionally, all this fear and concern about the US central bank starting to “taper” its asset buying program does not necessarily mean it is going to start tightening rates anytime soon or that the money supply will suddenly dry up.

We must remember that the various QE programs have been cumulative so that the liquidity pumped into the system has piled up and will not disappear overnight. It is only recently that banks have begun to grow their loans; previously they were using the liquidity supplied by the Fed to strengthen their balance sheets and were holding US Treasuries.

In addition, even if the Fed starts to pull back as the US economy improves, other central banks are still generating liquidity, which we feel could support investor flows into emerging markets. Japan has been embarking on a massive easing program, which is greater as a percentage of their GDP than the US’ program. While we worry about the long-term implications of inflation, if it can be avoided or offset by greater productivity gains, it could be a game-changer for many economies.

Overall, I believe emerging markets will likely continue to offer good long-term prospects for patient investors. There are always risks, and unexpected shocks could occur. But I still believe in the comeback story.

 

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