Emerging Markets Will Keep Rolling

10/16/2007 12:00 am EST

Focus: GLOBAL

Alexander Young

Equity Market Strategist, S&P Capital IQ

Alec Young, Standard & Poor’s international equity strategist, says broad demographic and economic trends should keep emerging markets growing strongly for a long time.

Emerging-market equities advanced 33.5% year-to-date through October 1, dwarfing far more modest gains for most developed markets. While there are concerns the rally can’t be sustained, we expect the group to continue to outperform.

Our bullishness is based on the growing global economic clout of emerging markets. As their domestic demand has soared and trade among developing nations and with Europe has increased, EM countries are less reliant on exports to the United States, and hence less vulnerable to a housing-driven US slowdown. This is fueling strong earnings gains, which, combined with low relative valuations, is likely to maintain healthy returns.

According to the International Monetary Fund, in 2006, emerging economies like China, South Korea, India, Brazil, Mexico, Russia, South Africa, and others accounted for 48% of global gross domestic product (GDP) and 69% of global GDP growth. In our view, this trend is only accelerating in 2007.

As for 2008, while we forecast only [around] 2% real GDP growth in the United States, Europe, and Japan, we expect [growth of between 4.7% and 7.8%] for Asia (ex-Japan), emerging Europe, the Middle East, and Latin America. Favorable demographic trends, increased industrialization and urbanization, and growing consumption of finished goods and services are responsible for the shift in global growth leadership.

We expect these trends to continue for decades to come. By 2050, the United Nations estimates the working age population of developing countries will climb to 5.1 billion, up 52% from 3.37 billion in 2005. Conversely, the developed world’s labor pool will decline 11% to 730 million from 823 million in 2005.

In addition, as emerging markets transition from agricultural to service—and manufacturing-based economies, we think industrialization [and urbanization] will rapidly expand. Urban migration is shifting the balance of power in global consumption growth from the US consumer towards emerging markets, where per-capita incomes are rising sharply as the urban middle class expands.

Consensus forecasts call for 2008 emerging-markets earnings growth of 13.7% vs. a 7.8% gain for developed overseas stocks and a 12.2% increase in the S&P 500. Despite higher projected profit growth, EM valuations, at 13x estimated 2008 earnings, are lower than those of both US (14.3x) and developed overseas equities (13.2x).

While the pace of future gains will likely moderate, the bull market in EM equities has further to run. We think EM equities should represent a core, long-term holding in US investors’ portfolios—some 5% of our 60% recommended worldwide equity weighting.

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