Emerging nations: a beacon of opportunity
By Jerome Booth, Financial Times
If you are looking for a market bubble do not look to emerging markets. The US and Europe remain a huge super-bubble. Emerging markets, by contrast, are safe. Putting one’s head in the sand and denying this reality has the attraction of plentiful company, but constitutes the opposite of prudence. Remember, lemmings also like to crowd together and the collective name for them is a “suicide”.
Unlike Europe and the US, emerging markets do not have a credit crunch, in essence a multi-year, very painful, deleveraging – that is, wealth destruction. But if you have not experienced 30 years of rising financial leverage, the past 10 to excess, you cannot get a credit crunch. Emerging markets are in a very different cycle to the developed world now, with inflationary not deflationary pressures.
The above comments will appear outrageous to some no doubt, just as my musing some years ago in a London club that Russian sovereign debt was a better credit than General Motors caused consternation to the listening ear of a nearby gentleman (subsequently a friend and convert). Prejudice is a powerful adversary for emerging markets, but also gives us a clue as to how allocation will shift only gradually to a more rational and prudent shape.
But is it not the case that emerging markets will be at least as risky if the developed world falls into the abyss? No.
Although of course they will be negatively impacted, they will still be the safest place on the planet to invest. They are not mere peripherals. Emerging markets are 50 per cent of global gross domestic product, using purchasing power parity, and have the bulk of industrial production, energy consumption, land, labour and growth. Their problem of too much dependence on the crash zone of Europe and the US is something mitigated by their strong domestic demand growth and which they are addressing through more south-south trade and investment.
But is it not the case that emerging markets are prone to bubbles? Not compared with the developed world super-bubble, or which cannot be dealt with through appropriate domestic policies.
Given the main motive for investing in emerging markets should now be because they are safer than the submerging (developed) markets, one should first look at fixed-income in emerging markets. So, more specifically: is there a bubble in emerging debt? There is not. Indeed there is the very opposite of a bubble dynamic – a strong, barely started, structural shift. Emerging market debt is a $9,200bn market, which may seem large, but is small compared with the underlying GDP of the countries concerned. This is the part of the planet which is capital scarce. Supply of debt is therefore totally elastic in all but the very short term. If there is $1,000bn of new demand in the next six months there will be $1,000bn in new supply, largely to build domestic sovereign yield curves and in corporate debt issuance.
The size of the emerging debt market is thus driven by demand, which is growing in an iterative way because of behavioural constraints. I am a big believer in GDP weighting – cap-weighted indices of publicly listed securities (typically misnamed “investible”) are a very poor representation of global investment opportunities. A better measure of global economic activity – and hence the full universe of investment opportunities – is past income – GDP, and that implies 50 per cent allocations to emerging markets.
Also the largest problem in the institutional investment industry arguably is misaligned incentives, which causes massive herding. It is the combination of these two deficiencies, combined with prejudice about emerging markets and inexcusably deficient concepts of risk and uncertainty that lead to gradual allocation.
A pension fund manager told me recently: yes, he agreed that GDP weighting was sensible and he was massively underweight, and yes, the industry suffered from herding where everyone was watching their peers, but he still had to be in the herd, though he could be at the edge of the herd. The result is that institutional investors invest a fraction of what they think is appropriate in emerging debt until their peers catch up and the result is gradual allocation over a period of many years. This is currently happening with many different types of investor peer groups all over the globe. Hence we have a gradual structural shift, not a temporary reversible move.
Today we face the risk of imminent currency dislocation threatening the dollar, and a growing risk of depression economics in the US.
The developed world is shouting hard for more investment capital – the question is: are investors going to give it to them or rethink risk, rethink tired asset allocation conventionalities and think for themselves?
Jerome Booth is Head of Research at Ashmore Investment Management
Categories: Africa / Middle East, Asia, Eastern Europe, Food for Thought, Investment Wisdom, Latin America, Stocks, The Big Picture, Trends, Patterns, Indicators