Growing pains
Sep 2nd 2004
Sep 2nd 2004
From The Economist Global Agenda
Emerging economies’ stockmarkets, especially those in Asia, look attractive
OUR emotional responses to the world—how we react to other people and events—are largely shaped in early childhood. Changing these responses, however destructive they are, is hard. It is, however, possible. Likewise, emerging markets, as Buttonwood has commented before, are shaped by their own, usually miserable, pasts—a big reason, of course, why they are still emerging. Think of China and Russia and their decades of communist rule. But change they can. Russia has thrown off its communist yoke; China has been dabbling with a perestroika of sorts. The question is whether such change is in the right direction; and if so how quick it is. Also, just as important is whether investors are rewarded for taking the risk of buying assets in such economies, when both the pace and direction is uncertain. Ponder, if you will, the example of the Russian government and its treatment of Yukos.
Domestic investors in the emerging economies themselves, long dogged by unstable regimes and disastrous economic policy, are of course very interested in the answers to these questions. If they did not have strong qualms about the risks and rewards of investing at home, they would hardly be investing so much of their hard-earned savings in US Treasury bonds that yield a sniff over 4% (thereby financing America's huge current-account deficit). But investors from rich countries are also interested, for the good reason that expected risk-adjusted returns in their domestic markets are now so low. Where, when public pension systems are so strained and unreliable and likely to become more so as their populations age—the subject of last week’s central bankers’ shindig at Jackson Hole, Wyoming—should they pop their cash? The answer increasingly given by many is emerging-market equities. And perhaps to the surprise of those who think this column merely a font of scepticism, Buttonwood is inclined to agree.
After putting in a performance last year of which even Michael Phelps would have been proud (had he been a country, the American swimmer would have come 16th in the Olympic medals table), emerging-market equities have had a rough few months. The MSCI emerging-market index peaked in early April and then, well, sank. In part, this was because investors became convinced that inflation in the rich world (and the emerging part, too) was about to take off and thus that central banks, the Fed not least, would have to increase interest rates sharply.
But their pasts also caught up with many a market. In Russia, for example, there were worries that if the government was able to use the courts to go after Yukos, one of the country’s biggest oil companies, then no one was safe. In India, the newly elected coalition government had to seek the support of the communists, who are not known for their reformist credentials. China seemed about to suffer one of its periodic busts, the severity of which could be predicted only by the height of the euphoria in the preceeding burst of enthusiasm from investors worldwide for the Middle Kingdom. And if China sneezed, an epidemic seemed likely to afflict the rest of Asia. In fact, thanks to a combination of cheap valuations, robust foreign flows, and stimulative monetary policy, Asian shares look likely to bob up quicker than most.
Domestic investors in the emerging economies themselves, long dogged by unstable regimes and disastrous economic policy, are of course very interested in the answers to these questions. If they did not have strong qualms about the risks and rewards of investing at home, they would hardly be investing so much of their hard-earned savings in US Treasury bonds that yield a sniff over 4% (thereby financing America's huge current-account deficit). But investors from rich countries are also interested, for the good reason that expected risk-adjusted returns in their domestic markets are now so low. Where, when public pension systems are so strained and unreliable and likely to become more so as their populations age—the subject of last week’s central bankers’ shindig at Jackson Hole, Wyoming—should they pop their cash? The answer increasingly given by many is emerging-market equities. And perhaps to the surprise of those who think this column merely a font of scepticism, Buttonwood is inclined to agree.
After putting in a performance last year of which even Michael Phelps would have been proud (had he been a country, the American swimmer would have come 16th in the Olympic medals table), emerging-market equities have had a rough few months. The MSCI emerging-market index peaked in early April and then, well, sank. In part, this was because investors became convinced that inflation in the rich world (and the emerging part, too) was about to take off and thus that central banks, the Fed not least, would have to increase interest rates sharply.
But their pasts also caught up with many a market. In Russia, for example, there were worries that if the government was able to use the courts to go after Yukos, one of the country’s biggest oil companies, then no one was safe. In India, the newly elected coalition government had to seek the support of the communists, who are not known for their reformist credentials. China seemed about to suffer one of its periodic busts, the severity of which could be predicted only by the height of the euphoria in the preceeding burst of enthusiasm from investors worldwide for the Middle Kingdom. And if China sneezed, an epidemic seemed likely to afflict the rest of Asia. In fact, thanks to a combination of cheap valuations, robust foreign flows, and stimulative monetary policy, Asian shares look likely to bob up quicker than most.
In 2002, foreign investors only popped $300m, net, into emerging stockmarkets, according to the Institute of International Finance. Last year, that had risen to over $27 billion, the highest in seven years; and this year the IIF expects the number to reach $33 billion or so, though it expects flows to Asia, which almost doubled last year, to fall. Alas, its calculations were published in April, just as stockmarkets peaked and foreigners headed for the exits. Its predictions have presumably been reduced since then. But better, surely, to be invested in assets that have been shunned than those that everyone loves and, almost by definition, already owns. And there are good reasons to suppose that emerging stockmarkets will start to look decidedly attractive again to those that have fled, if only because almost everything else looks so pug ugly.
For one thing, the interest-rate cycle seems to be turning. Rising interest rates, or at least the threat of them both in American and in many emerging countries, have cast a pall. But given ample evidence of a slowdown, the Fed is unlikely to be in a hurry to put up rates very fast or very much, even though they are, by historical standards, ludicrously low. With the probable exception of China, central banks in some emerging markets already seem to be cutting. South Korea, South Africa and Hungary have all reduced rates in recent weeks.
Possibly, it is true, these rate reductions are cause for worry, since they reflect economic weakness, in Asia not least. Stockmarkets in Taiwan (another candidate for a rate-cut) and South Korea have also been battered by weak demand for their high-tech exports. Profits growth has stalled. While oil-exporting countries have gained from a strong oil price (though not necessarily investors in their oil companies: see Yukos), oil importers have suffered—and most of Asia falls into the latter camp. The higher oil price has added up to $100 billion to non-Japan Asia’s oil bill compared with last year, according to Credit Suisse First Boston.
On the other hand, China does not seem headed for a bust, not for now at any rate. Nor does Japan, though growth there is slowing. As long as these two carry on growing, there is every reason to think that companies elsewhere in the region should continue to prosper. The big question for the world economy is whether Asia can detach itself, and take over leadership, from a slowing United States. A punt on Asian assets—which have anyway provided much of the world’s growth in recent years—is in essence a bet that it can. Assuming, that is, that America doesn’t fall through the floor.
Moreover, current emerging-market valuations do not need to be bailed out by rapidly rising profits in the same way that they do on Nasdaq, to reach, at random, for one example. They are, in fact, quite cheap, especially in Asia, which should provide comfort even if America slows and its stockmarkets fall. The price/earnings ratio for emerging markets as a whole is now just over 12—about half its level in 1994, when the Fed was last tightening rates, and getting on for a historical low. On present expectations for next year’s profits, South Korea’s stockmarket has a p/e multiple of just six.
For one thing, the interest-rate cycle seems to be turning. Rising interest rates, or at least the threat of them both in American and in many emerging countries, have cast a pall. But given ample evidence of a slowdown, the Fed is unlikely to be in a hurry to put up rates very fast or very much, even though they are, by historical standards, ludicrously low. With the probable exception of China, central banks in some emerging markets already seem to be cutting. South Korea, South Africa and Hungary have all reduced rates in recent weeks.
Possibly, it is true, these rate reductions are cause for worry, since they reflect economic weakness, in Asia not least. Stockmarkets in Taiwan (another candidate for a rate-cut) and South Korea have also been battered by weak demand for their high-tech exports. Profits growth has stalled. While oil-exporting countries have gained from a strong oil price (though not necessarily investors in their oil companies: see Yukos), oil importers have suffered—and most of Asia falls into the latter camp. The higher oil price has added up to $100 billion to non-Japan Asia’s oil bill compared with last year, according to Credit Suisse First Boston.
On the other hand, China does not seem headed for a bust, not for now at any rate. Nor does Japan, though growth there is slowing. As long as these two carry on growing, there is every reason to think that companies elsewhere in the region should continue to prosper. The big question for the world economy is whether Asia can detach itself, and take over leadership, from a slowing United States. A punt on Asian assets—which have anyway provided much of the world’s growth in recent years—is in essence a bet that it can. Assuming, that is, that America doesn’t fall through the floor.
Moreover, current emerging-market valuations do not need to be bailed out by rapidly rising profits in the same way that they do on Nasdaq, to reach, at random, for one example. They are, in fact, quite cheap, especially in Asia, which should provide comfort even if America slows and its stockmarkets fall. The price/earnings ratio for emerging markets as a whole is now just over 12—about half its level in 1994, when the Fed was last tightening rates, and getting on for a historical low. On present expectations for next year’s profits, South Korea’s stockmarket has a p/e multiple of just six.
The Bank Credit Analyst, an independent research company, suggests a longer-term reason for the attractiveness of Asian shares: the region’s companies are making more money. The Asian crisis of the late 1990s shattered elements of the Asian growth model, which had relied on size for its own sake, and put the money generated by rising productivity into the hands of consumers. But profits as a percentage of GDP and returns on equity have risen sharply since the crisis, as a result of restructuring and a focus on profitability. Only when the pain gets bad enough, it seems, will economies, like people, change.
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