Mark Mobius, about as famous as anyone as a guru for investing in emerging market stocks, admits the charts for the past two years don’t look good.
“Emerging market equities have underperformed developed markets for the past 12 and 24 months,” he says. “But emerging markets have outperformed on a five- and 10-year basis.”
The question is, will emerging markets resume their march to glory? Or has the asset class entered a new, less glamorous era?
This being Mobius, executive chairman of the Templeton Emerging Markets Group – the title gives it away – his answer is that the current travails are a blip and that EM outperformance will resume.
He spoke via video link at a conference organised by Korea’s National Pension Service last week (a typhoon prevented his private jet from landing in Seoul).
Mobius blames the recent relative underperformance on oversupply. This year, emerging market companies are expected to account for up to 40% of new issuance worldwide, collectively more than the US. They are up in absolute terms as well, with $450 billion of new EM issuance in 2010, $250 billion last year and probably a further $250 billion this year. That dampens secondary markets.
That supply is not being met by demand yet. Thanks to more share issuance and valuation gains, EM equities now account for 34% of global market capitalisation, up from 8% in 1999. Yet the average investor’s exposure is still 3-8%. This suggests investment flows to emerging markets will only go up, and as demand rises relative to supply, so will prices.
The reason to expect such flows is still economic growth. Asia and other emerging markets may not be roaring along as they did two or three years ago, but they are still outpacing developed markets. China, India, Indonesia, Thailand and places such as Nigeria will deliver 5% or better GDP growth this year.
That is thanks to rising populations that spur consumption; Mobius cites rising imports as evidence of this consumer boom, along with rising rural household wealth and low penetration levels of goods, from cars to computers.
It’s not just demand for such things that drives consumption, but the growing connectivity with the rest of the world. As internet and telecom penetration deepens, it drives demand for goods and fuels participation in the global consumer economy.
Other macro aspects of EMs remain positive, argues Mobius. Their fiscal positions remain superior, as evidenced by the rise of foreign exchange reserves (now $7 trillion across EMs) and by the rise of foreign direct investment flows from emerging market companies to acquire targets in developed markets; last year saw $150 billion of such flows, mostly to the US, UK, Australia and Canada. And their sovereign credit ratings are improving while public debt as a percentage of GDP continues to decline in many EMs, thanks in part to steady decreases in inflation.
Finally, valuations: Mobius says the average EM equity market’s price-to-earnings ratio is 10x, versus 12x for developed markets (as of August). And emerging markets are generally more attractive on price-to-book or dividend yield terms.
But Mobius cites risks. One is demand: investors are de-risking, which will hamper EM valuations for the time-being. In some markets, unemployment is rising, which could lead to social unrest. Export-oriented countries are vulnerable to a Western slowdown, although Mobius suggests this threat is overdone, as EM exports to the US and Europe are already in decline anyway.
There is the risk that EM governments spend more than they can afford on social welfare. Volatility remains a constant for EMs, although Mobius adds that investors can take advantage of this, too. Finally he cites big systemic risks such as the derivatives industry: with $647 trillion of notional contracts outstanding, 10 times more than global economic output, losses could be tremendous.
But then that would be true whether you’re in an emerging or a developed market.