This article has been written by David Semple for Morningstar Australia. Semple is head of emerging markets equity at Van Eck Global, an investment management firm.
The tide is turning for emerging markets, which we believe are poised to offer higher economic growth in the medium term, particularly as investors diversify away from their domestic economies and seek better earnings growth from emerging-markets economies.
The asset class attracted particularly strong inflows in April and May of this year, the highest inflows since March 2013. In fact, emerging markets outperformed the broad U.S. market in the second quarter of 2014 -- an event we've not seen for some time. We believe the asset class is on track to offer higher economic growth for the remainder of 2014 (versus previous corresponding periods) and as we move into 2015.
When considering investment in emerging-markets economies, we believe the main risks to consider are geopolitical and interest-rate sensitivity. However, despite geopolitical risk, most emerging-markets countries have absorbed a significant amount of bad news. We see good opportunities in Taiwan, India and Latin America.
- Ongoing tensions in Ukraine have impacted the Russian economy and the escalation of sanctions will have a broader impact on a fragile European economy. The earnings impact from the sanctions as they exist today is fairly mild. However, we think the cost of equity will rise as investors shy away from the possibility of further and more serious geopolitical tension, combined with the possible implementation of full sanctions on listed companies.
- China continues to provide a mixed picture. There is a wide range of opinions and a great deal of scepticism about the China story. There is a continuing tug of war between significant positive and negative economic variables. We believe the ongoing modest and targeted stimulus is expected to continue and keep growth above the 7% to 7.5% level. It's important not to forget the positives, such as the fact that China has the largest e-commerce economy in the world.
- The decisive win for the Bharatiya Janata Party, or BJP, in India appeared to be beneficial for the stock market, although there are hopes for better governance and acceleration of capital expenditure in the near term.
- In Brazil, the outcome of the election in early October will be important. We expect that a change of government will have a positive impact and will help reinvigorate the stagnant economy.
- Indonesia has some very significant long-term advantages in terms of demographics and resources, but has significant work to do to increase the return on those assets. This will mean increasing the ease of doing business, whether by investing in infrastructure, streamlining bureaucracy, reducing subsidies, or providing a level playing field for investments.
On the stock level, some strong performers in emerging-markets economies in the second quarter of 2014 include Axis Bank (India) and BB Seguridade Participacoes (Brazil). Both are good-quality, well-run franchises with potential opportunity for growth, in our view.
In the technology sector, the strong performers were DEN Networks, a cable operator in India currently benefitting from the digitalisation and rationalisation of that industry, and Baidu, a company that has a strong position in the Chinese internet search space.
Overall, we approach the balance of 2014 with optimism. In our view, the global economy could continue to accelerate gradually. Monetary conditions may also tighten eventually, but could remain accommodative, and valuations generally remain attractive.
Emerging markets were considered unattractive at the start of the year, but we feel that the tide is turning. And while at this stage investors may still be unreservedly bearish on the asset class, the degree of pessimism appears to have abated.
