My Optimistic Outlook for Emerging Markets

Since early last summer, the performance of emerging market equities has been disappointing at best. Investors withdrew an estimated $26 billion from emerging market equity funds last year. Today, there is a high-level of pessimism about the asset class. The downturn in emerging markets essentially started last May with what has been described as a “taper tantrum” over concerns of the impact of the U.S. Federal Reserve’s eventual tapering on emerging market economies.

Many investors are concerned regarding emerging market currencies and the likely impact of the continuation of the Fed’s tapering. The big risk in emerging markets this year is focused on currencies and how they will react to the macro environment, with many investors concerned about the ability of emerging markets to deal with reduced liquidity. These concerns have unfairly impacted many investors’ long-term views of emerging markets economies. Many investors have also conveniently forgotten about the growth engines of many of these countries, specifically population growth and an increasing consumer middle class.

I’m continuing to take a longer-term and optimistic view of emerging and frontier markets. I have concluded that a repeat of the emerging market economic crises of the 1990s are unlikely. Some poorly managed countries, such as Argentina, may default again, but I am not concerned regarding contagion. Most emerging market economies are in pretty good shape despite the impact of the Fed’s tapering and their own economic and political challenges. These countries will benefit from any general global upturn in growth.

So, what should an investor do? To me it’s clear. When one looks at the longer-term prospects for emerging markets, it’s easy to conclude that many of the countries will serve as engines of global growth. Some countries immediately come to mind. These include China, Indonesia, Mexico, Poland and Brazil. The sell-off in equities in many of these countries provides a real buying opportunity for those investors who understand the impact of huge populations and the increasing middle class in many emerging markets.

What does this mean for entrepreneurs and business owners in emerging markets who are dealing with the challenges of obtaining local bank credit or having difficulty in accessing equity? For these companies, there has never been a better time to seek foreign capital from investors who are cognizant of the long-term prospects for many of these countries and who truly understand the causes and minimal long-term impact of the Feds’ tapering and its short-term effect on currencies.

Author: Jeffrey Friedland
Email: jof@friedlandcapital.com
Twitter: @jeff_friedland

Jeffrey Friedland is the author of “All Roads Lead to China: An Investor Road Map to the World’s Fastest Growing Economy,” which is available in print and Kindle editions at Amazon and other booksellers.

He is the CEO of Friedland Global Capital, a firm that assists companies in emerging and frontier markets in achieving their corporate finance objectives, and specifically accessing global equity capital.

Finally, Good Economic News from Brazil

One year ahead of the Football World Cup, a major focus of the world and investors has been on Brazil, and for good reason.  Brazil’s economic health is critical for all of Latin America..

Most of the economic data coming out of Brazil over the past few months has been negative. I was pleased when recently published data showed an improvement in Brazil’s economic activity for October.

The index of Brazil’s central bank, the Banco Central Do Brasil’s IBC-BR index rose .77 percent in October, a greater rate than anticipated.  A Reuters survey of analysts had indicated a consensus of a .5 percent increase as being more likely.

This October data is a significant improvement,  It diminishes the likelihood that Brazil will enter a technical recession after the fourth quarter. This is good news for Dilma Rousseff’s government, and is an indication that Dilma will have little difficulty in getting re-elected in 2014.

Wednesday, Brazil’s Finance Minister, Guido Mantega, said:

“The Brazilian economy is, since the second half of 2012, in a trajectory of gradual recovery that should continue in 2014. There’s been a strong recovery of investment, which has grown 6.5% up until October from private and public sources.”

Mantega also indicated that inflation was under control, and that Brazil’s government was anticipating lower inflation in 2013 than 2012.

Brazil has established an annual inflation target of 4.5 percent, but allows for what it refers to as a two percent “margin of tolerance,” which would allow for a maximum annual inflation rate of 6.5 percent. In November, the twelve-month inflation rate was 5.77 percent.

Brazil’s economy grew strongly three or four years ago, but stalled last year. This October data, as well as the improvement in other economic indicators is positive. Hopes are that the country will achieve an annual growth rate of three percent in the fourth quarter of 2014.

Brazil is important for global investors. As one of the BRIC countries, Brazil has brought brought millions of people out of poverty and has started to develop a highly educated workforce.

With Mexico, Brazil makes up more than 60 percent of the Latin American economy, with the growth of both countries being significant for all of Latin America.

As is the case with most emerging and frontier markets, there is a concern as to the impact of the U.S. Federal Reserve action, when the Fed starts tapering its quantitative easing. Mantega has indicated that Brazil was ready for the tapering and was not concerned about what many foresee as a period of global market turbulence once the Fed’s tapering starts.

Author: Jeffrey Friedland

Twitter jeff_friedland

Jeffrey Friedland is the author of “All Roads Lead to China: An Investor Road Map to the World’s Fastest Growing Economy,” which is available in print and Kindle editions at Amazon and other booksellers. His is the CEO of Friedland Global Capital. 

Why Ben Bernanke Wasn’t in Jackson Hole

The Federal Reserve chairman, Ben Bernanke was noticeably absent from the Kansas City Fed’s annual gathering in Jackson Hole, Wyoming. I can’t recall a Jackson Hole event where the Fed chairman wasn’t in attendance.  The official explanation was that he had a previously committed personal conflict.  This definitely could be the case, but it is just as likely that it isn’t.

With his term ending, Chairman Bernanke is in a lame-duck position.  My conclusion is that he didn’t want to be at the Jackson Hole event.  I don’t think he wanted to be barraged by questions regarding the tapering of Quantitative Easing.  I also don’t believe that he wanted to be confronted with questions regarding the impact of the tapering on the U.S. economy.  Most importantly, I believe that Bernanke would  prefer the  impact from tapering and eventually the ending of QE not being on his watch.

Because Bernanke wasn’t in Jackson Hole,  instead of the sessions being dominated by U,S, Fed policy, the focus of the event became the impact on emerging markets from the Fed’s tapering.

Just the talk of tapering has resulted in an increase in long-term interest rates in the United States.  That has led to a flight of capital from emerging markets including Brazil, India and Indonesia. These countries and others have seen their exchange rates also fall.  The talk of tapering has also led to a decrease of  global stock market value of $3 trillion.

In Jackson Hole, the International Monetary Fund’s Christine Lagarde was quoted as saying that the world needs to build “further lines of defense” against a crisis in emerging  markets.  This comment seems to indicate that she is getting ready  for the worst.

Other than a resurgence in the housing markets in some U.S. cities due to low mortgage rates, and the stock market having reached new highs, I’m not sure that QE had a significant positive effect on the U.S. “real” economy. U.S. economic growth  is still minimal and real U.S. unemployment hasn’t significantly been impacted.

I’m going to watch carefully the impact of tapering on emerging and frontier markets. It’s likely that many countries are going to be in for a roller coaster ride.  I’m also nervous about the political  implications of what will likely be a tumultuous period for many of these countries. Negative effects could include  political instability.

Investing in Emerging Markets and Frontier Markets is Still Compelling

The recent sell-off in U.S. markets once again highlights the uncertainties for the U.S. economy and the U.S. markets. Prior to the sell-off, the market performance over the past months was a contributing  factor that motivated many investors to move out of fixed income or cash and into U.S. equities. Some investors moved out of emerging market equities into U.S. equities, a move many may regret.

With the run-up this year in the U.S. markets, many investors have become frustrated with emerging and frontier markets, which is understandable. As part of a long-term investment strategy, the argument for investing in emerging and frontier markets is perhaps more compelling than ever.

A question I have often been asked over the past months is, “Why invest in Indonesia, Mexico or China, when I can get double digit returns by investing in U.S. companies?”

While growth in many emerging and frontier markets has slowed, so has U.S. growth, and growth in other advanced economies. But, emerging markets will likely grow at a rate significantly greater than that of advanced economies, including the United States.

China will not return to its thirty-year average annual growth rate of over 10 percent anytime soon. But, it is likely that China’s growth will finish this year at or slightly under 8 percent, which I view as impressive, especially under global economic conditions.  Compare China’s growth rate for this year with the 2013 growth estimates of less than 2 percent for the U.S., and maybe one-half of one percent for the euro zone.

Another factor is valuations. Economies of many emerging markets have significantly better growth prospects than those of advanced economies, shares of companies in emerging markets trade a an average 30 percent discount to those of advanced economies. Shares of the BRIC countries of Brazil, Russia, India and China are trading at less than 10 times earnings, with the exception of India.

Factors that investors found compelling about emerging markets over the past few years are still valid.  Many emerging markets are continuing with the liberalization of their economies. Most have debt to GDP ratios of less than 50 percent, compared to 100 percent in the United States and 200 percent in Japan.

Rather than abandoning emerging markets, investors should consider augmenting investments in emerging markets with investments in frontier markets. The MSCI Frontier Market Index increased 15 percent through mid-July,an increase about the same as U.S. markets, and better than most global market benchmarks. There are geopolitical issues that impact many frontier markets. But, maany of the frontier markets, especially those in Africa and the middle east, are among the fastest growing countries worldwide.

A caveat for investors is that shares of emerging and frontier markets should not be seen as part of a trading strategy,  but instead as part of a long-term investment strategy.  I am not suggesting that investors sell all their U.S. equities and instead move into emerging or frontier markets, but instead, that investors should have exposure to the emerging and frontier markets as part of an overall asset allocation strategy.