Tide may be turning as earnings start to recover

Yet many investors have often viewed emerging markets as a homogeneous asset class, in spite of the substantial economic, political, and geographic differences.

In the six years preceding the global financial crisis, the MSCI Emerging Markets index had a 29 per cent annualised return, in dollar terms, compared with almost 20 per cent for global developed markets.

Remarkably, only two emerging markets had annualised returns below 20 per cent, with 17 of the 25 markets in the index posting annualised gains exceeding 30 per cent.

In contrast, in the subsequent six-year period, emerging markets had an annualised loss of 0.9 per cent, compared with 3 per cent for developed markets. Only half of the emerging markets managed positive returns.

However, the tide may be turning this year, with investors showing more selectivity after last year’s broad, indiscriminate sell-off.

India and Indonesia, spurred by hopes new political leadership will bring renewed economic growth, and the Philippines gained more than 20 per cent in the first half. Meanwhile, several other markets – including Russia, China, Chile, and Mexico – continued to struggle.

Importantly, the market’s tendency to lump emerging markets together creates a great opportunity. While corporate earnings growth in aggregate in the emerging world has slowed since the peak in 2011, what seems to be overlooked is that this was largely driven by Latin America, the most materials-intensive part of the emerging world. At the same time, earnings in emerging Asia reached an all-time high last year.

In fact, emerging market earnings overall have fully recovered from levels preceding the global financial crisis, along with those in the US. Earnings in Europe and Japan remain well below pre-crisis levels.

Valuations have generally moved up from the trough reached last year, but there are still parts of the emerging world where negative sentiment has driven valuations to levels out of sync with the superior fundamentals and return potential.

There are particular opportunities in markets such as India, Indonesia, the Philippines, Turkey, Peru and Mexico. There are also positive frontier markets, including Nigeria, Vietnam and Myanmar.

For all the gnashing of teeth about India last year, it has grown at a 5 per cent rate in the past two years.

The country has a young population, low GDP per capita, tremendous upcoming growth in the labour force, rising urbanisation and middle class, as well as dynamic new growth sectors.

Its significantly under-built infrastructure also poses both a challenge and opportunity.

The stars are also aligned in the well-run economy of the Philippines, which has a balance of payments surplus and moderate inflation.

Indonesia has some materials and energy exposure, but not nearly on the magnitude of Brazil and South Africa. With demographics, infrastructure development and low GDP per capita in its favour – the economy should grow at a 5-6 per cent rate, or potentially even greater. The country is moving in the right direction and new political leadership could be a catalyst.

Turkey was labelled as one of the ‘fragile five’ in 2013, but the policy steps the country implemented last year have been handsomely rewarded this year. The country has a robust, long-term economic outlook, with very favourable demographics.

While there is near-term political uncertainty, valuations should rerate higher once it is resolved.

Scott Berg is portfolio manager of the T. Rowe Price Global Growth Equity fund