After a disappointing 2011, emerging market assets are poised to continue their recovery in 2012 and represent improving value, says Aberdeen Asset Management.
Like many investors, Aberdeen was surprised in the second half of last year as Greece’s problems rippled through the banking system. Global capital flows were directed away from emerging markets to the US dollar and other safe havens. Local currencies fell along with equities and bonds, making returns worse for hard currency investors.
But this was less a flight to safety than to liquidity; now that the ECB has bought time in Europe and US data may be improving, some of those flows are reversing, which explains the strong performance of risk assets so far this year.
In Aberdeen’s view, the core attraction of emerging markets is their superior fundamentals, and any periodic weakness in markets is an opportunity to add to positions. It cites faster growth rates, ongoing structural adjustment (with a focus away from exports to consumption) and strong trade and fiscal balances as points to consider.
While attention in Asia naturally gravitates to a moderate pace of growth in China, the bull case is that the slowdown there only follows a two-year credit boom, easing property prices are tempered by the low level of borrowing among buyers and banks have relatively low loan to deposit ratios. Even if its demand for commodities stayed flat, China would still exert a strong pull globally.
Perhaps the key point for emerging markets is their proactive policy management. Central bankers have flexibility that the West lacks. Falling inflation and interest rates are very positive generally for emerging market assets. There is room to stimulate growth if need be. Contrast this with the balance sheet recession that, for all the money printing, could still tip the West into a deflationary crisis.
Aberdeen believes investors should adopt a selective approach to emerging markets. Spreads on emerging market debt are now attractive, given the low default risk both in corporate and sovereign bonds. But currencies broadly look under-valued. On the equity side it sees a weaker profits trend for this year, with flat or nominal growth, yet here again prices have in many cases fallen to compensate that.
Kevin Daly, Portfolio Manager of Emerging Market Debt at Aberdeen Asset Management, says: “The backdrop is still constructive for emerging markets debt despite slowing global growth. Hard currency spreads are attractive given the low default risk, and corporates also offer good value. We expect both emerging sovereign and corporate debt to outperform as investor risk appetite increases.”
Mark Gordon-James, Senior Investment Manager of Asia Pacific Equities at Aberdeen Asset Management Asia, adds: “Although we are seeing some growth rates decline across emerging market countries, none of these matter that much provided governments grasp the nettle and push ahead with structural reforms. Fortunately inflation remains broadly under control and there is room for pump-priming. While macro-economic uncertainties are omnipresent, we believe the long term outlook remains attractive for well run companies.” He further adds, “Companies are doing very well now because wealth is being recycled into a strong and growing urban middle class that is willing to spend. But to fend off cheap imports they have to become more competitive.”