EM fundamentals remain superior

It is an unfortunate fact of investing in emerging markets that they remain a ‘high-beta’ asset class, amplifying the moves of developed markets. It is no wonder therefore their performance was poor in 2011.

Last year, $35bn (£22.1bn) came out of emerging market equities as US and European investors repatriated capital. But this contagion represents an excellent long-term opportunity to invest in the superior fundamentals of emerging markets.

Over a five-year timeframe, emerging markets will benefit from public balance sheets that are in far better condition than those in developed markets. They will also reap the benefits of stronger economic growth. On an annual basis, emerging economies as a whole grow roughly 4 percentage points faster than developed economies, in recessionary as well as in expansionary periods.

This is not to say that emerging markets are all in the exact same condition. China is in a very strong situation. Once it has managed to bring property prices under control, it will have the capacity to manage a soft landing of its economy.

The reason for this is that inflationary pressures have now started to recede, so that China will be able, if necessary, to bring support to its economic activity where needed via a more accommodative monetary policy (including lower reserve requirements for banks).

India, by contrast, has been a disappointment. A lot of expectations had been created by the re-election of prime minister Manmohan Singh in 2009, whose program included several important reforms. But unfortunately, little has happened since.

In the meantime, inflation was pushed up by oil prices, and the Indian rupee suffered. In India, we have also clearly seen the top in inflation. Therefore, the Reserve Bank of India is in a position to continue cutting rates, which will benefit both the economic activity and the valuation of financial assets.

In Russia, there is little doubt to say the least that Vladimir Putin will return as president in 2012. It is however, unclear how the government will deal with the discontent, and the capital flight which has become progressively worse in 2011.

In Brazil, infrastructure bottlenecks still exist which the government needs to deal with, so as to significantly reduce the structural inflationary environment. But there as well, prices have started to come down, while monetary policy have until recently been very restrictive. Consequently, there is much scope for monetary easing from currently still very high real rates.

To put things into context, one needs to realise that the starting point is strikingly different from 2011. A year ago, inflation rates were rising across the emerging universe, and accordingly, monetary policies were increasingly restrictive.