Investing In A Low Growth, High Debt World

| About: Templeton Emerging (TEI)


Developed economies have accumulated a lot of debt, limiting the choices policyholders have in terms of economy stimulation.

Emerging market economies not only have low levels of debt, but are also the fastest growing, especially Asia.

Valuations in the emerging markets are very attractive and this may be the right time to increase exposure.

The world economy continues to slow as policy makers attempt to find additional ways in which to stimulate the economy, while simultaneously remaining committed to the existing accommodative monetary policies. The global economy is likely to grow by approximately 3% this year, a far cry from the over 5% achieved in 2010 (chart 1).

The low, or in many cases negative, interest rates do keep the economy afloat, but just barely. Many experts have urged for fiscal measures to complement existing monetary policies in order to stimulate the economy. However, this might be hard to achieve given how high developed world debt levels are today. Both public and non-public debt in the developed world has grown to approximately 265% of GDP (see chart 2). According to the below chart, the rising overall debt levels are primarily due to the public sector, which began its ascent after the great recession of 2008. Private sector debt, as a percentage of GDP, has actually come down, as businesses have remained cautious throughout the same period. The high public debt levels leave very few tools in the hands of policy makers to revive growth. This low growth, high debt, low interest rate world presents a unique challenge to an asset allocator.

Chart 2

Source: Ned Davis Research

At Lynx, we believe the answer, while not easy, is to look more closely at the various constituents of the global economy, and then at individual asset classes in order to uncover less obvious and highly fruitful areas of investment. One such opportunity resides in the emerging world.

We are of the opinion that emerging markets, especially those in Asia, should do well in this environment. According to the IMF, the GDP forecast by region suggests that the strongest growth exists among emerging countries, particularly in Asia (chart 3). Not only do emerging markets have stronger growth, they also have lower levels of debt. As chart 4 indicates, the trend among emerging markets has been essentially the opposite of that seen among developed countries. Though overall debt in the emerging markets has risen as a percentage of GDP, it is primarily due to the private sector, while its public sector debt has remained relatively steady at 24% of GDP. Lower public debt in the emerging markets gives policy makers in these countries more choices - choices that their counterparts in the developed world cannot afford.

Chart 3

Source: Ned Davis Research

Chart 4

Source: Ned Davis Research

As discussed, emerging markets have both growth and low debt levels. Thus, the question then becomes, should investors increase their allocations to these markets? We believe the answer to this question is yes, at least based on valuations. At this point, we don't think the positive environment in emerging markets has been priced into the capital markets yet, and we attribute this to investor concern and caution around both the uncertainty in China, as well as the Federal Reserve interest rate policy. According to chart 5, emerging markets are trading at extremely cheap valuations based on the historical price to book ratio. The emerging market equity valuation is the cheapest we have seen in many years. The next question is then, how best to seek exposure to the asset class. The answer, of course, is contingent on an investor's liquidity needs, risk tolerance, and return objectives. An investor looking for yield, albeit with some volatility, can invest in sovereign debt of emerging markets using open ended or closed-end mutual funds. Templeton Emerging Markets Bond Fund (NYSE:TEI), is a closed-end fund an investor might consider. This fund is managed by an experienced and highly regarded team. It currently trades at an over 10% discount and offers slightly more than a 7% yield. Unlike most closed-end funds, TEI is not levered, which would suggest less volatility as compared to other closed-end funds in this category (please note, some of Lynx's client portfolios hold this investment). As always, we strongly encourage investors to do their own due diligence before investing.

Chart 5

Source: Cambridge Associates

In summary, while the developed world appears to have tepid growth and high levels of debt, emerging markets are better positioned for growth. For those investors who have a longer-term investment prospective and are willing to accept short-term volatility, the cheaper valuations in emerging markets provide an attractive investment opportunity today.

Disclosure: I am/we are long TEI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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