Given this divergence, we believe certain areas will continue to attract foreign investor flows in the short term and, once the Fed has raised interest rates, more investors will start to re-evaluate the potential for individual emerging markets over the longer term.
Even with slower growth in China, EMs as a whole are likely to grow faster than DMs over the next decade and the global shift in economic power from West to East will continue. China is already the world’s second largest economy and the Shanghai and Hong Kong stock exchanges combined have one of the largest market capitalisations globally.
The IMF has said it anticipates a recovery in emerging market growth in 2016 and a long-term trend of mid single digit growth, well above the expected “new normal” for growth in developed markets.
Over the last 20 years, EM growth has been driven by mass urbanisation, economic reforms and the emergence of a new middle class with aspirations to Western living standards. Over the next 20 years, we would expect these trends to continue. According to an Ernst & Young report, the global middle class is set to expand by another three billion people by 2030, coming almost exclusively from the emerging world.[1] Moreover, these drivers will be accompanied by other factors such as increasing intra-regional trade through organisations such as ASEAN (the Association of Southeast Asian Nations) and technological advances that should enable certain markets to leapfrog the years of gradual improvement in developed economies and go directly to more efficient, modern systems.
Despite the recent sugar rush in China, EM valuations continue to appear attractive both at an asset class and a company level, with valuations generally, measured by P/B, below 5 to 10 year averages. Once the anticipated rate hike from the Fed is passed, we could see a reassessment of emerging areas as the divergence between EM countries widens and growth prospects become less of a concern.
[1] E&Y report: Hitting the sweet spot: the growth of the middle class in emerging markets, April 2013