The next big thing

Now the race is on to identify the emerging countries that will be the next big thing. But investing is not about word play and clever acronyms, and the growing disparity between emerging market economies makes grouping countries in this way much more difficult. Besides which, Viper sounds cooler – Vietnam, Indonesia, Philippines, Egypt, Romania – though it is completely meaningless.

Even the well-used Bric grouping no longer holds as strongly as it once did, as there is a vast dispersion between the drivers of these economies and the rungs of the development ladder they have reached. A recent Bank of America Merrill Lynch fund manager survey showed that, within emerging markets, fund managers were overweight China and underweight Brazil. A simple comparison of these two countries illustrates why the grouping of emerging markets can be dangerous from an investment point of view.

Brazil is a commodity-heavy market, which has meant company profits have been dampened by the weaker global demand for raw materials. Its economy struggles with higher inflation, which can give rise to a certain amount of social unrest, evidenced by the San Paulo riots in June last year. Since the swift market reaction to the US Federal Reserve’s tapering talk took hold last summer, the flight of capital out of the country has led the Brazilian central bank to sharply increase the benchmark interest rates to defend a falling real – most recently surprising markets with a 50 basis point rise in the base rate to 10.5 per cent, the seventh increase since March 2013.

Contrast this to China, whose economy, while slowing, is being transitioned to a more sustainable growth path with a roadmap having been set out in the Third Plenum. Inflation is not a significant problem and even the housing market appears to be coming under control. This means that monetary policy can be used to support growth in China rather than hinder it, as in the case of Brazil.

Investors should not forget that emerging economies are just that: emerging, but all at different rates. As they continue to develop, they will be subject to periods of strong growth disrupted by periods of political instability and/or economic reforms which will dampen economic output. However, these are countries that, even at a slower pace of growth, will burn through developed world rates. The International Monetary Fund recently upgraded its growth forecast for advanced economies in 2014 by 0.1 percentage points, from 3.6 per cent to 3.7 per cent.

Long-term economic and market drivers do not change very frequently, and investors would be wise to view emerging markets as a long-term allocation, riding out the ups and downs and not getting too caught up in the latest acronym craze.

While the developed countries are leading the global recovery, emerging markets continue to deliver much stronger growth in absolute terms – the IMF also increased its growth forecast for China by 0.3 per cent to 7.5 per cent, and many emerging markets will benefit from the rebound in the developed world.

Emerging markets were the pariah of the investment world in 2013, and the Merrill Lynch survey shows just how unloved emerging market equities have become. According to the survey, a net 15 per cent of investors are underweight emerging market equities, which is a full two standard deviations below the 10-year average for this survey. This creates opportunities.

Rather than deterring investors from investing in emerging markets, the experiences of 2013 should instead remind them to be more selective about how they access the asset class. This means looking at many of the long-term drivers of individual economies – demographics, market conditions, regulatory backdrop – rather than focusing on one in particular.

The Mint – Mexico, Indonesia, Nigeria and Turkey – grouping, for example, was based solely on all these countries having a similar demographic profile and dismissed other aspects of their economy. Long-term economic and market drivers do not change very frequently, and investors would be wise to view emerging markets as a long-term allocation, riding out the ups and downs and not getting too caught up in the latest acronym craze. Otherwise, they may risk missing the forest for the Trees – Thailand, Romania, Egypt, and Ecuador – again, meaningless.

Kerry Craig is global market strategist for JP Morgan Asset Management