By Borge Endresen, CFA, Senior Portfolio Manager
Interest rates are rising, and the commodities complex has softened, which, although beneficial for commodities importers such as Turkey, India and China, is clearly negative for the region as a whole. Revised earnings expectations continue to be a headwind, although the pace of earnings downgrades has slowed considerably since the middle of 2013. In addition, weakening currencies aggravate inflation, which complicates the scenario for the central banks of these countries.
Given the dominance of negative headlines these days, I think it is important to remind ourselves of the positive elements - and opportunities - in emerging markets.
- Emerging markets are experiencing far greater policy uncertainty than developed markets at this time. But it's important to remember that stocks were weakest during times of significant policy uncertainty in developed markets - for example, the U.S. in 2009 and Europe in 2011, which, in hindsight, were clearly great buying opportunities.
- Returns on equity (ROE), a good indicator of quality, remain higher in emerging markets than they are in developed markets (although emerging markets ROE is currently trending down).
- Earnings expectations appear to be stabilizing and valuation levels look far more attractive for long-term investors.
- With emerging markets awash in negatives, investors may have lost sight of this opportunity: 90% of the world's middle class will be in emerging markets by 2030, according to the World Bank. It is simply too large a piece of the global economic pie to simplistically avoid. Most of the reasons the investor community got excited about emerging markets a decade ago still hold today.
Over the long term, we believe the best predictor of future equity returns is the valuation paid today, as investors tend to make more money when they buy low and sell high. Emerging markets currently offer very low valuations, and we believe long-term investors should not forget this positive indicator among the negative headlines.
Return on equity (ROE) is the amount of net income returned as a percentage of shareholder equity. In general, stock and other equity securities values fluctuate in response to activities specific to the company as well as general market, economic and political conditions. The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues. An investment in emerging market countries carries greater risks compared to more developed economies. Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.
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