U.S. woes could boost emerging markets

By Vikram Barhat | August 11, 2011 | Last updated on August 11, 2011
3 min read

As nervous investors grapple with the U.S. credit rating downgrade and the resultant market uncertainty and panic, the world continues to be reshaped. With renewed vigour, advocates of emerging markets are pointing out deteriorating debt metrics in the developed world, contrasting it with improving debt metrics in much of the emerging world.

“There’s going to be great opportunities [in emerging markets] as [developed] markets keep on tanking,” says Mark Mobius, executive chair of Templeton Asset Management’s emerging markets group.

In the face of the widespread post-downgrade market crash, he says, the situation remains unchanged for emerging markets. “They continue to have high foreign exchange reserves and low debt-to-GDP ratios, and people are going to eventually wake up to that reality,” he says.

Indeed, currencies and stocks of emerging countries look relatively attractive, given that emerging markets generally have more foreign reserves than developed countries and that debt-to-GDP levels of emerging countries tend to be lower than developed countries.

“This improved ability to manage their currencies and historically better ability to service debt are why we believe emerging market currencies have been so strong and may continue to be,” says Mobius.

This situation, he says, is not new; this has been happening for the last few years.

It may be argued that, traditionally, skittish investors tend to run to gold and U.S. treasuries (not equities) at the first sign of uncertainty, as they did in the 2008 financial crisis.

But this time it’s different, says Mobius. “The anchor of the U.S. dollar and the U.S. treasury is gone,” he says. “So people are now searching to where the safety is, and their first reaction is to move into cash because they believe it’s safe; of course, they’ll wake up to the reality that cash is not king.”

It won’t be long before we start to see some focus returning to emerging markets that are looking good from an economic point of view, he says.

The recent sell-off over concerns in many developed markets has created an excellent buying opportunity for investors, says Paul Mesburis, senior portfolio manager with Excel Funds.

“Current troubles notwithstanding, emerging market countries—including China, India, Russia and Brazil—continue to be the drivers of growth in the global economy,” he says. “The United States and Europe are now in the passenger seat along for the ride.”

A recent IMF report claimed that as soon as 2016, a short five years away, China will replace the U.S. as the world’s largest economy. This tectonic shift in economic power is a precursor to the new world order, says Mesburis.

While industrialized economies face myriad headwinds—a high debt/GDP load, large structural budget deficits, low birth rates and an aging population—emerging markets continue to grow at about three times the rate of their developed counterparts.

“With that in mind, we would recommend that investors view this current market turmoil as an opportunity to buy the dips and take advantage of attractive valuations currently on offer in emerging markets,” says Mesburis. “Companies in emerging markets continue to exhibit healthy balance sheets, growing sales and strong management teams.”

There is a growing resonance to the idea of emerging markets as a haven for investors seeking stability and reasonable returns. “If the U.S. credit quality has deteriorated in the way that Standard & Poor’s suggests, what are the alternatives?” asks Philip Poole, global head of macro and investment strategy with HSBC Global Asset Management.

It seems highly unlikely that investors will sell treasuries to move into Italy, which is now in the eye of the eurozone debt storm, or into Japan, which lost its AAA rating a decade ago and has worse debt metrics than the U.S.

Poole says the need for de-leveraging in the U.S. and elsewhere in the developed world is likely to have negative implications for companies operating there. “Companies focused on developed world demand, wherever they are based, are likely to be vulnerable,” he says, adding that investors should seek out thematic anchors where the fundamental rationale is strong.

“These are likely to be mostly emerging market themes but should be played through a global portfolio,” says Poole. “Such themes include overweighting emerging consumption and infrastructure themes via emerging and developed market stocks exposed to these themes.”

Vikram Barhat