The East powers ahead while America stumbles
Ian Cowie asks whether high-growth economies such as China’s are a safer bet than those of the debt-laden West Emerging markets have been the most profitable game in town for several years now, even after the setbacks some suffered toward the end of 2007. True, the bears enjoyed a bit of a picnic when China funds — easily the biggest single country segment of the emerging markets sector — fell by about a fifth of their value in January. Now the big question for investors is whether the bull is dead or merely pausing for breath.
Wiseacres have been calling the top of these markets all the way up, but relative returns since 2003 have called into question conventional assumptions about risk. While developed countries’ stock markets have been hit hard by the credit crunch, emerging economies have powered ahead. Consumer debt is a major worry in America and Britain but scarcely an issue in Brazil, Russia, India or China. The so-called BRIC economies’ populations are relatively untroubled by the credit crunch for the simple reason that few have credit cards, let alone mortgages, subprime or otherwise. Seen from that perspective, which are the ‘safe’ and which the ‘risky’ regions now?
Unlike the developed nations and their increasingly distressed debtors, emerging economies have built up massive reserves by supplying many of the goods we’ve been buying on tick. According to analysis by Urban Larson, a director at Foreign & Colonial Investments — which has been investing in emerging markets for more than a century — these countries now hold US$3.5 trillion in foreign currency reserves, rather more than two thirds of the global total.
Depending on how you analyse the figures, emerging markets may also account for slightly more than half of global GDP, yet all the shares on their stock markets comprise less than a quarter of global market capitalisation. At its simplest, the gap between those two figures is the bull case for enthusiasts who believe there is more to come, as valuations in emerging economies catch up with those in more developed countries.
The bears, on the other hand, argue that it’s absurd to imagine anyone can be immune from recession in America, which is still by far the biggest economy in the world. Christian Deseglise, global head of emerging markets at HSBC Investments, sums up the conundrum: ‘Financial analysts are struggling to determine the relevance of the old adage: “When America sneezes, the rest of the world catches a cold.” After five years of strong global growth, largely led by emerging markets, their resilience in the face of a possible American recession is being tested. While they will not escape unscathed from a full-blown recession in the developed world, they’re now in robust shape and, in the event of a mild recession, they should weather the storm and continue their shift to centre-stage in the world economy.’ One reason to believe that process can be sustained is the emergence in many of these countries of a substantial middle class — which also means a domestic mass-consumer market — for the first time. HSBC estimates that while a quarter of the goods and services produced by emerging markets were exported to America at the start of this century, the total is nearer 16 per cent today. Likewise, F&C calculates that exports to America account for only 12 per cent of China’s GDP, 3 per cent of India’s and barely 2 per cent of the economic output of Brazil or Russia.
So there is increasing scope for these countries’ own consumers to take up the slack if shoppers in America and Europe take fright. Some of the most bullish analysis on that point comes from investors in China. Martha Wang, manager of Fidelity China Focus Fund, claims: ‘In the near term, the slowdown in America is unlikely to have significant impact on China. It may actually benefit China, by supporting the focus on more sustainable, domestically driven growth.... Long-term fundamentals in China remain intact and I look at periods of weakness as buying opportunities.’ Similarly, Philip Ehrmann, manager of Jupiter’s China fund, says: ‘In contrast to the well-trumpeted concerns about the weakened state of the global economy, China’s problems appear to be the reverse — too much growth. Exports have held up, while domestic activity has been robust. As a result, GDP growth for the year just ended is expected to exceed 11.5 per cent with inflation remaining close to an 11-year high. As a result, the Chinese authorities are continuing their tight monetary policy in an attempt to rein in excess liquidity. In this instance, however, it has been a question of preventing overheating rather than meltdown.’ So, when George Soros told the plutocrats at Davos last month that economic power was shifting from West to East, this was not so much the shocking revelation it was presented to be by the awestruck media, but rather a statement of an increasingly conventional view. Charlie Awdry, manager of the Gartmore China Opportunities Fund, summed it up: ‘Although the US is still the world’s largest economy, global dynamics have changed and the Chinese economy became the largest growth contributor in 2007. I believe that de-rating has been excessive in China, and not commensurate with the tighter monetary policy environment announced in December.’ Perhaps at this point I should declare an interest. I invested in Gartmore China several years ago — before Awdry took the reins, indeed back when Philip Ehrmann was managing it — and, even after recent setbacks, I have nearly doubled my money. The same is true of a longer-standing shareholding in Pictet East European investment trust. During August 2007, the last time markets took fright and many investors convinced themselves the world was coming to an end, I also picked up some shares in JP Morgan’s Indian trust for my self-invested personal pension. They cost 328p then and have been as high as 500p since, before falling back to 427p as I write this. Not bad for six months in a bear market. Considering the battering my supposedly ‘safe’ shares in Britain’s highstreet banks have suffered recently, these emerging economies’ performance has demonstrated that there are risks in being out of markets as well as in them.
On a longer view, however, it is cautionary to remember that most emerging economies have been here before. Yellowing busted bonds from Tsarist Russia and Imperial China, which still adorn the walls of some oldfashioned stockbrokers, serve as a memento of that unhappy fact. Can globalisation and the internet really mean it will be different this time? Or will events demonstrate the truth of Christopher Fildes’s observation on these markets? About 20 years ago, as a cub reporter, I found myself writing about busted Russian bonds and Christopher — even then the sage of the Daily Telegraph City office — told me: ‘An emerging market can be defined as a market from which it is difficult to emerge.’ That implicit warning may prove more relevant now than it did then.
Ian Cowie is personal finance editor of the Daily Telegraph.
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