Investment Adventures in Emerging Markets

Emerging Markets in 2011 – Strong Economies, Rising Prices

I believe emerging markets are now in a secular bull market, and as discussed below, I expect this trend to continue into 2011. Even more money is likely to be directed into these markets as investors around the world realize that emerging economies on average are growing three times faster than developed economies, and generally have more foreign reserves and lower debt-to-GDP ratios than their developed counterparts.

The International Monetary Fund has estimated that emerging markets will grow an average of 7.1% in 2010 and 6.4% in 2011, well above the 2.7% and 2.2% growth (in 2010 and 2011, respectively) estimated for developed markets. Meanwhile, foreign reserves in China are the largest in the world, totaling more than US$2.6 trillion. Similarly, Russia has more than US$450 billion, while India and Brazil have more than US$250 billion each in reserves.[1]

Although the slowdown in the global economy had an impact on some emerging markets, we are seeing that these economies are becoming more domestically driven. Private domestic consumption and government expenditure in areas such as infrastructure have at least partially offset the impact of decelerating export growth. The services sector has, in our view, also been gaining in importance, especially in China and India. Generally, I believe that the economic recovery in emerging markets is likely to be sustainable in view of their strong fundamentals. In addition to robust macroeconomic data, financial and fiscal indicators remain positive. Moreover, the search for higher returns in a low interest rate environment coupled with attractive valuations in emerging markets could continue to support equity prices.

However, emerging economies may face inflationary pressures from the capital inflows spurred by continued loose monetary policies in developed markets. In addition, if central banks in emerging markets continue to buy dollars to prevent their currencies from appreciating too quickly, thereby increasing their foreign reserves, they may appear increasingly safe to investors looking for markets with higher economic growth and yields. This may lead to a “vicious cycle”, which could have some untoward consequences and therefore, this buying activity needs to be watched carefully. Monetary and exchange rate policies around the world could also impact markets, and so we continuously track the situation.

Emerging markets, like most other global equity markets, will, of course, experience corrections along the way, given the prevalence of short selling, the increasing use of derivatives and the expansion of markets globally. However, short-term volatility may provide investors with appealing entry points if valuations drop to attractive levels, while over the longer term, emerging markets should reflect the underlying strong economic growth in those countries.

Most important for us as value investors, we believe that current valuations in emerging markets are still more attractive than those in developed markets, despite having risen from the extreme lows of early 2009. We thus continue to be able to find what we believe to be attractively valued stocks on an individual basis in most emerging markets.

Happy holidays! I hope you can find time to enjoy this festive season with friends and family – probably one of the best “investments” you will make. I also hope one of your resolutions for the coming year is to invest wisely. As Sir John Templeton once said, “Focus on value, because most investors focus on outlooks and trends.”

[1] Source for this paragraph: IMF, World Economic Outlook, October 2010.

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