Last week the IMF lowered its 2012 growth forecast, saying it now expects global growth to slow to 3.3%, down from its earlier view of 3.5%. This year is now on track to lag 2011’s growth of 3.8%, and it will remain far below 2010’s robust growth of 5.1%. The outlook for 2013 isn’t much better with expectations that growth will be flat or lower in most developed countries.
These sobering forecasts are reinforcing my view that investors should consider being overweight emerging market stocks.
Let’s look at the United States. The U.S. economy is expected to grow by about 2% next year, assuming that the government can avoid the fiscal cliff. But as I’ve said, from conversations we’ve had with politicians, there’s better than a 50/50 chance the United States will go off the fiscal cliff. If that happens, and the tax hikes and spending cuts scheduled to take effect in January actually hit, there is a strong likelihood that the United States would suffer at least a mild recession.
Outside of the United States, European growth is likely to be flat, with modest growth in Germany and perhaps France, but the rest of the continent still contracting. Growth in Japan is expected to decelerate to around 1%.
However, the story in emerging markets looks more encouraging. While nobody expects China or India to return to their glory days of 10% or more annual growth, things may pick up next year. Growth in China could accelerate from 7.8% this year to 8.2% in 2013. Expectations are even stronger for Brazil, where the economy is expected to grow by 4%, versus a lackluster 1.5% in 2012.
One reason for the optimism is that most emerging markets–particularly China and Brazil–have been aggressively easing monetary policy by lowering interest rates. For example, in Brazil, short-term rates have fallen from over 12% to an all-time low of 7.25%. Typically, monetary policy works with about a six- to 12-month lag. Just as tighter monetary policy in 2011 was a drag on growth in 2012, this year’s easing should be supportive of growth in 2013.
Despite the fact that emerging markets are set to significantly outpace developed markets, the valuation of stocks remains low in emerging markets compared to those in developed markets. Emerging market countries are still trading at around a 20% discount to developed markets. With inflation stable and growth set to accelerate, we think the relative difference in value offers a good opportunity for investors looking to gain access to growth in a slow growth environment. As such, we would advocate that investors overweight emerging market equities heading into the new year. In particular, we continue to like China, Brazil, Indonesia, and Russia. For retail investors seeking a less volatile strategy, we would consider the iShares MSCI Emerging Markets Minimum Volatility Index Fund (NYSEARCA:EEMV).
Disclaimer: In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. The Fund may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.