All grown up?

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Last year, economists at Morgan Stanley debated adding another member to the top tier of emerging markets: with Indonesia expecting solid economic growth in 2011, the country should be included among the ranks of key markets, with BRIC countries Brazil, Russia, India and China, they argued. That debate underscored a larger question about who belongs where: with growth in many of those countries surpassing that in more mature economies, have emerging markets outgrown the “emerging” label?

The forecast for many so-called BRIC countries suggests they may have. Morgan Stanley predicts GDP growth in emerging economies will jump from 1.6% to 6.5% in 2010—with China headed for 10% growth—while expected GDP growth for G10 countries will remain markedly lower, at “barely 2%.”

“Who is emerging, who is developed, sometimes it’s hard to differentiate,” says Chuk Wong, vice-president and portfolio manager with Dynamic Funds.

Driving growth Several factors are driving China and its BRIC counterparts forward. In China, changing demographics and higher incomes have created a growing consumer base and a higher GDP. With other emerging economies nearby, China has lessened its reliance on exports to Western countries, and is also moving away from low-value manufacturing activities like textiles, notes Eng Hock Ong, managing director of AGF Asset Management Asia.

“Over the last few years, the [Chinese] government recognized that the export model is not sustainable,” he says. “Consumption will be a major driver of growth.”

And a recent Barclays report also credits so-called foreign exchange “war chests,” improved fiscal policies and the benefit of Chinese economic momentum for gains in other Asian countries and Latin America. Such factors “neutralized the domestic amplifiers of external shocks that triggered contagious EM crises in the past,” the report states. It even goes so far as to re-brand Singapore, Chile, Korea, Taiwan, Israel and China as “Advanced Emerging Markets” that have “graduated” from traditional EM volatility and are “halfway between the traditional EM and developed open economies.”

Adding to stronger fundamentals—like lack of corporate and government debt—increasing money supplies around the world means that “more money is looking for a home,” points out Dr. Mark Mobius, executive chairman of Templeton Asset Management, LLC and lead manager for Franklin Templeton Investments’ emerging market funds.

For the most part, the advancements—and growth—appear sustainable. In 2009, emerging markets accounted for more than half of the global GDP, and 34% of that was in Asia alone, notes Sean Cleary, CFA, and BMO professor of finance at Queen’s University. “Those kinds of numbers suggest that over the next 10 to 15 years, those economies will continue to grow very rapidly,” he says. “There’s a lot of push to be maintained in the mid- to long-term.”

Closing the gap The prospects may be bright, but are they enough to earn new status—if not a new classification, as Barclay’s suggests—for emerging markets? Have they truly decoupled from the developed world?

In some ways, they have, fund managers say. The very factors that fuelled gains—a growing middle class, more investment in infrastructure, etc.—point to a certain degree of independence. And, as the U.S economy continued to struggle with recessionary fallout in 2009, China’s own economy gained ground, points out Wong. “Economically, there is a high degree of decoupling.”

But the transformation still has a ways to go. Even China, the BRIC leader, “is definitely still an emerging economy,” says Ong. Waning growth in developed markets shows that emerging economies must diversify even more, he says, pointing to a recession-related contraction for those emerging economies without a sizeable consumer base. “[The] collapse in growth of developed countries has been a bit of a threat.” And certain non-BRIC countries, like Vietnam, Pakistan and South Korea still have an element of geopolitical risk.

Not only are some markets still vulnerable to foreign equity fluctuations, accounting and governance practices also still need work, adds Wong, who notes managing the new economic growth will be a key challenge. At that level, “I think true decoupling will take some more time,” he says. “But longer term, the gap between emerging markets and mature economies will narrow.”

Capitalizing on growth Decoupled or not, the growth in new markets offers opportunity for investors. Retail investors can look to mutual funds, or hedge funds, with high exposure to emerging markets. ETFs are another option for Canadian investors, notes Cleary, who points to rapid growth in that investment class.

And even as growth continues, true decoupling may be impossible, notes Ong. “I think the world is becoming a lot more integrated, so decoupling away from the development of the global economy is getting a little bit more difficult,” he says. “[Countries] grow and do decouple, but the markets don’t.”

(05/04/10)