InvestmentsFeb 8 2016

Can Asia stand out from the EM crowd?

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Can Asia stand out from the EM crowd?

Investors like to sort things into neat categories. It helps them make sense of a highly complex world. Categories like Gems, Brics and the fragile five have all been invented as easy-to-understand groupings of supposedly similar countries.

Yet we have to be careful of such generalisations because the more research you do, the more you realise there are often more differences than similarities between the members of these acronyms.

Take Brics as an example. Aside from the fact they are all large countries on the cusp of developed market status, you’d be hard pushed to find four more different countries than Brazil, Russia, India, China (and South Africa, which is sometimes included as the ‘S’ in Brics). Linguistically, culturally, geographically, historically, politically and economically they are all about as different from one another as you can get.

At a time of marginal improvements in the US and European economies, rising US interest rates and a strong US dollar, the consensus view is that developed markets should outperform emerging markets. Yet the broad global emerging markets grouping (Gems) covers a multitude of different countries, economies and markets.

There is a strong argument to be made that the Asian component of this emerging market universe may perform relatively well compared with the non-Asian component.

The first reason for this is growth. While in the short term there is no correlation between GDP growth and stockmarket performance, in the long term there is some linkage. GDP growth is slowing everywhere in the world. Low growth is the new normal as the world continues to work its way out of the leveraged excesses of the pre-2008 period. But Asia is growing at a substantial premium to the developed world and to non-Asian emerging markets.

The key to this growth is the expansion of the middle class. Many people like to talk about the very rich in countries such as China and India, but the story of consumption growth in Asia is not a Prada handbag story. It’s a story about people entering the middle class from below; moving from the countryside to the city, getting their first job, and buying their first television and mobile phone.

According to data from the Brookings Institution, Asia is set to add more than 2.5bn people to its middle class by 2020. Asia of the last decade was a place that made things for other countries; Asia of the next decade will be a place that makes things for its own consumers.

The second argument is about disciplined economic management. Asian emerging markets learnt some useful lessons in the currency crisis of 1997-98.

After that, the economic model changed from an export model with current account deficits and capital account surpluses and pegged exchange rates to a domestic-demand model, with floating exchange rates and current account and fiscal surpluses.

In the majority of Asian countries you now see current account and fiscal surpluses, low levels of foreign exchange debt and high levels of foreign exchange reserves relative to GDP. This is not the case in some of the larger and more challenged non-Asian emerging markets.

Thirdly, Asian governments seem to have embraced the need for reform. Japan (not an emerging market, of course, but an important example of reform in Asia), China, India and Indonesia have all embarked on ambitious reform programmes to make their economies fit for purpose.

Each country has different reform needs, and there are many challenges pushing these agendas through in the face of vested interests. Investors would like to see reforms progressing more rapidly, but the intention is there even if the pace is lacking. In general we do not see the same reform-mindedness in non-Asian emerging markets.

Next, low commodity prices are generally beneficial to Asian countries. All the main markets of Asia are net oil importers. Lower oil prices help improve the terms of trade, allow governments to cut fuel subsidies if they exist, helping governments’ fiscal positions, and reducing energy costs for companies and households, benefiting margins and consumption. This is obviously not true of those non-Asian emerging markets dependent on commodity exports.

Lastly, Asian equity markets have more listed companies to choose from than Europe and the US combined, making the region a fertile stock-picking investment environment, and regional markets are almost two standard deviations cheaper than history relative to developed markets.

Matthew Sutherland is head of product management, Asia, at Fidelity International