Expert: Bet on emerging markets

By Vikram Barhat | May 19, 2011 | Last updated on May 19, 2011
3 min read

While governments in industrialized economies are taking a softly-softly-catchee-monkey approach to monetary tightening, those in emerging markets have been more aggressive and have been able to successfully stymie inflation.

Paul Mesburis, senior portfolio manager at Excel Funds, goes so far as to say monetary tightening in emerging markets is history.

“Monetary policy tightening began in earnest in emerging markets some time ago because they are cyclically ahead of the developed world in terms of being concerned about inflation,” he said in a recent conference call. “Our perception is that this inflation [in emerging markets] is peaking soon; the point that we would make is that monetary policy tightening is largely behind us, in the emerging market world, whereas it’s at the beginning in the developed markets.”

The tightening has caused some fears about the level of equity valuations in emerging markets which lead to equities in these markets to underperform versus developed markets. Mesburis asserts the peaking of inflation means emerging market equities will be able to lift their performance.

He makes a particularly strong case for China where he says inflation is expected to top out at 6% and will drop to 4% by the end of the year. With inflation about to peak, forward P/E multiples at about 11, below their long-term average, and a growth of 9%, China remains very much the lead character of the emerging market growth story.

“In China right now there are 57 cities with a population of more than 1 million, and that number will grow by nearly four times in 2020 when there will be at least 220 cities with a population of over one million,” said Mesburis. “Brazil will spend nearly a trillion dollars alone to upgrade their infrastructure. Both Brazil and Russia will be hosting a World Cup and an Olympics over the next few years. India has announced an infrastructure program of over a trillion dollars in the next several years.”

He draws attention to some numbers to support his economic arguments for emerging markets. “We are at a P/E of 11 and a half times forward earnings; we are looking for 15-20% earnings growth in the emerging markets this year; double-digit returns for emerging markets are easily achievable.”

Speaking about numbers, emerging markets represent over 80% of the world’s population, over 70% of its land mass, 70% of its global foreign exchange reserves and nearly 40% of the global GDP, but only 13% of the global equity market gap.

“That discrepancy, in essence, is one of the significant growth drivers of future equity returns,” said Mesburis. “We expect that in 20 years emerging markets will represent 55% of global equity markets, which is about a six fold increase for present in terms of dollars.”

Add currency appreciation to the equation and investors are in for an even bigger bang for their buck. “We’re also seeing pressure on emerging currencies, and we believe that currency appreciation will be a positive contributor to returns.”

Although growth in emerging economies has been slowing, but at 6.2% a year it is still nearly three times the growth of industrial counters. Mesburis predicts continuation of a two-speed world where emerging economies will persistently outpace those in the developed world.

Mesburis remains optimistic about global markets’ ability to shake off the effects of current geopolitical events as he continues to recommend investing in emerging markets, particularly emerging market bonds. “From a market perspective, [earthquake in Japan] is a short-term event for the market, and the market has already digested this event and has moved on,” he said.

Although Japan’s growth will be negatively impacted this year, there will be a longer term positive impact from its reconstruction efforts over the next two to three years, he added.

“We have also had some political unrest in parts of the Middle East and oil prices have increased because of that [but] we believe that this will bring about positive change as the focus in some of these countries will be on improving people’s livelihoods and creating new jobs.”

Vikram Barhat