Emerging market currencies, whose weakness added to the losses suffered by emerging mar¬ket equity investors in 2011, are now showing signs of strength as foreign investment flows back.
Emerging market equities bore the brunt of growing risk aversion among investors, who feared earnings would be hit by fading growth in developed economies. Consensus estimates at the start of 2011 predicted that profits would rise 25% over the year, but by the end of the year the figure came in at just 10%.
Earnings forecasts for 2012 remain at 10%, which we consider realistic if emerging markets’ economic growth is 6% and inflation runs at around 4%.
A key factor in driving better emerging market returns has been renewed confidence in the outlook for China, where the slowdown appears more cyclical than structural. We believe inflation will continue its recent decline in 2012, allowing an easing in monetary policy.
That said, we expect only a gradual easing of monetary conditions, as the authorities will wish to retain control over bank lending after a period of credit expansion that led to lending excesses. Our view is that activity will slow further during the first half of 2012, which could lead to further weakness in the property sector.
Investors will scrutinise data for any signs of knock-on effects on consumer spending and on banks’ bad debt ratios, but we remain confident that China will deal with near-term cyclical pressures without triggering a deeper downturn.
Emerging market equities are looking relatively cheap in terms of price/earnings and price/book ratios, which are both well below long-term averages and close to levels that have in the past revived the risk appetite of investors.
Some markets look particularly good value – we believe Russia, for example, will offer compelling opportunities once the March elections remove political uncertainties.
India is another. It was shunned by investors last year as political paralysis stalled economic reforms and undermined the currency. But having been underweight in India for some time, and with the country’s leading indicators improving, we are moving back to a neutral position, largely through increasing our exposure to the banking sector.
