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Mark Dampier: Value remains in emerging markets

Despite their recent high-profile setbacks, the long-term case for emerging markets remains strong and investors have an opportunity to top-up their holdings.

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I always enjoy reading financial and investment commentary in the press over Christmas and New Year, especially the predictions for the year ahead. This year I have to admit to having felt somewhat queasy.

I could find little in the way of negativity, but plenty of positive sentiment on the economy and stockmarkets. While the consensus can sometimes be right it is interesting to note the previous year most people were cautious and the result was stockmarkets in the developed world having one of their best years in a while.

So, here we are in the first week of February 2014 and stockmarkets, far from moving upwards, are going through a bout of nervousness and schizophrenia.

The source of the problem has been emerging markets, particularly their currencies which have been suffering heavy falls.

Unfortunately, in their mini-panic investors have reduced exposure almost indiscriminately, failing to distinguish between good markets and bad. It is hard to pinpoint a single cause behind the falls but among those cited are the mismanagement of the Argentinian economy by the authorities there; political corruption scandals in Turkey; riots in Ukraine; and worries over faltering economic growth in China. Commodity-rich economies have also been damaged as investors have shunned the materials and energy sectors.

Concern over the strength of emerging markets has been building for a while though. The developed world’s economic recovery has gathered pace over the past year and this has given the US Federal Reserve the confidence to begin tapering, that is, slowing its quantitative easing programme.

In recent years QE and the maintaining of ultra-low interest rates across the developed world encouraged investors to take more risk in search of higher returns and much of the influx of money ended up flowing into emerging markets.

This made it easier for companies and consumers to borrow. This can boost growth but with the developed world now scaling back QE and the prospect of interest rate rises drawing ever nearer money is flowing out of emerging markets and back towards developed economies in anticipation of higher returns.

Many emerging markets have perhaps had it too easy and they have not focused enough in recent years on structurally reforming their economies and boosting domestic demand. Instead they have hidden behind QE.

We have been here before. The Asian crisis in the 1990s was precipitated by the devaluation of the Mexican peso, for example. However, at the time of the last Asian crisis the lending boom was more widespread, meaning few economies were capable of tolerating higher borrowing costs when the US raised rates.

Today, many Asian and emerging economies have built up significant reserves with less foreign currency borrowings and exchange rates that are no longer pegged to the US dollar. This should make it easier to adjust gradually to changing global economic conditions.

Globalisation means emerging market problems have spilled over to the developed world too. Recent poor data from the US in terms of its manufacturing survey has not helped confidence. That said these are notoriously fickle numbers undoubtedly not helped by the vicious winter weather in the US.

Stockmarkets periodically go through consolidation and correction stages which can be painful but 10 per cent to 20 per cent drops after a strong period are not unknown. Investors need to keep their nerve. Indeed, those who have regular monthly savings plans could use this opportunity to increase contributions to take advantage of lower share prices.

Emerging markets have had a good 10 years so perhaps it is not surprising to see some problems appearing now. The long-term case for investing in emerging markets remains strong though. Remember the media generally focus too much on the short term simply because it generates great headlines.

Stockmarket falls are painful but provide opportunities to buy funds and stocks at lower prices. To be frank, valuations are not desperately cheap but nor are they expensive. While the US may continue to taper I see little appetite for rises in interest rates. Indeed, if anything they have been put further back. Therefore, if you have favourite funds and shares which have fallen in value you could consider topping up rather than panicking.

Mark Dampier is head of research at Hargreaves Lansdown

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