Around the World With Emerging Markets

04/17/2008 12:00 am EST


Alexander Young

Equity Market Strategist, S&P Capital IQ

Alec Young, global equity strategist with Standard & Poor's, says performance is wildly different among emerging markets, and he singles out several for special treatment.

Through April 4th, the MSCI Emerging Markets index declined 8.1% [this year]. But individual countries, such as Mexico (+8%) and Brazil (+1.6%), are in the ascendant, while former all-stars China (-18%) and India (-28%) are on the decline.

China's recent slide underscores the risks of chasing performance. Many global investors indiscriminately bought Hong Kong-listed, Chinese stocks in 2007 for what appeared to be endless growth opportunities and outsized returns. The merits of many other lesser-known, but more fundamentally attractive, developing markets fell by the wayside in the myopic rush to invest in the world's fastest-growing economy.

The MSCI China index peaked in late October and has since declined 35%. The most widely appreciated investment opportunities are rarely the most profitable. After a string of upward earnings revisions in 2006 and 2007, Chinese profit growth expectations are slowing. Despite expectations for a healthy 9.9% increase in real gross domestic product (GDP) growth in 2008, slowing economic growth around the world and a rising yuan are threatening exports.

[Meanwhile,] India is very dependent on a steady stream of liquidity from foreign institutional investors. In addition, rising inflation and continued Reserve Bank of India tightening have foreign investors worried that the estimate for 2008 earnings growth of 22% will be lowered. The uncertain political landscape is [also] keeping foreign investors sidelined as needed privatization and economic liberalization are not expected any time soon.

Meanwhile, [when] slowing US economic growth remains a major threat, the Mexican economy is expected to expand 2.6% in 2008, as record oil prices increase fiscal revenues and government spending. Strong energy and corporate tax reform momentum is helping offset investor fears about slowing US growth and driving solid Mexican equity performance. The Mexican Congress is currently debating needed energy reform that would allow some private investment in the previously nationalized sector. By contrast, the earnings picture is limited in most global equity markets, helping explain year-to-date Mexican equity outperformance.

Brazil is the largest emerging market, representing 15.1% of the MSCI EM index. While growth in most major economies is slowing sharply, Brazil is expected to post 5.1% GDP growth in 2008, roughly in line with 2007's 5.3% increase. Although the central bank has signaled its intent to keep interest rates unchanged as inflationary pressures mount, a series of cuts between September 2005 and September 2007 will continue to encourage investment and consumption.

Also, strong commodity pricing has investors comfortable with consensus forecasts for a 17% increase in 2008 earnings. [And] Brazil trades at only 11.7x consensus 2008 estimated earnings, making it one of the cheapest [emerging] markets.

S&P Equity Research recommends total portfolio weightings to emerging market equities of 3% and 6%, in our moderate and growth global asset allocations.

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