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Emerging markets have been the place to be over the past few years. The Morgan Stanley Capital International Emerging Markets index, which spans 26 developing countries, has hit a record peak of 624, more than twice its level of early 2003; it appears on track for a third successive yearly gain, which would be its longest winning streak since the early 1990s. So can these markets keep up this kind of momentum?
One reason for optimism is solid global growth, which Goldman Sachs reckons should endure for the rest of the year. But emerging markets are no longer purely a geared play on the global economy: with the gradual emergence of middle classes in emerging countries, domestic growth is being given a long-term fillip. Emerging markets still depend on exports, “but a broadening of the domestic economy provides another leg to the emerging markets stool”, says Brad Aham of State Street Global Advisors. Helped by strengthening consumption, emerging market economies will expand by 6.3% this year, while the industrialised world will grow by 4.3%, according to the IMF.
Developing countries’ finances, meanwhile, have improved markedly over the past few years. The soaring prices of raw materials – and hence rising commodities exports – boosted their collective trade surplus to 3.1% last year from 0.5% in 1998, according to Bear Stearns, which also notes that developing nations’ external debt is now down to 42% of GDP, compared to 52% in 1998, as higher export earnings have allowed emerging markets to curb borrowing. Structural reforms and fiscal discipline have made growth more sustainable and helped tame inflation.
Although the MSCI Emerging Markets index is on a p/e of 12, this is still considerably cheaper than major developed markets (Europe is on 14 and America on 19). Economic fundamentals “have improved beyond all recognition”, but equities are still only 20% above their 1995 levels, says John Paul Smith of Pictet. US money managers Grantham, Mayo and Van Otterloo (GMO) expect emerging equities to notch up real annual returns of 5.5% over the next seven years, while GMO co-founder Jeremy Grantham has come to see them as a “hedge”, deeming them likely to outperform Wall Street during a US market upturn and fare less poorly during a downturn. When a manager of $86bn for institutions and wealthy individuals calls emerging markets a hedge, “something important has changed”, says Chet Currier on Bloomberg.com. It seems emerging markets have “finally grown up”.
So which ones are the best bets now? Stephen Schurr in the FT points to Turkey, which is growing at 6%-7% amid falling interest rates and a “thriving” emerging middle class. On a p/e of 13, moreover, stocks are “still reasonable”. Korea “may be the best bargain in the world” with a p/e of under 10. Leading companies such as chipmaker Samsung (ticker: 05930, 562,000 won) “compare favourably with their global peers”, but cost around 50% less. Merrill Lynch, meanwhile, points to Russia, which is still “inexpensive”.
Funds specialising in global emerging markets include the Genesis Emerging Market fund and the Templeton Emerging Markets investment trust, up by 161% and 140% respectively over the past three years; Korea is currently the biggest regional weighting in both cases. Independent financial adviser Bestinvest highlights the Jupiter Emerging European Opportunities fund, which sticks to eastern Europe and is heavily exposed to Russia
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