More than two decades ago, I decided to study Thai at university. It was challenging and time consuming, but what I found toughest were the jibes I received from acquaintances. They couldn't understand why I wanted to learn such a language. They asked whether it was so I could chat up the Thai ladies'. The ridiculing continued throughout university, but when I landed my first job in Thailand and flew off to Bangkok, the mocking suddenly stopped.
I see the same thing happening to emerging markets. Recently these markets have suffered mainly because of concerns about a global economic slowdown and the threat of the US Federal Reserve's more restrained bond buying. Last week emerging market bonds, equities and currencies slumped, fuelled by a sharp sell-off. Many pundits have been quick to write off emerging markets completely.
But I believe that is a too hasty conclusion. When my university friends mocked me, I came across a delightful Gandhi quote on his observation about persistence in activism: "First they ignore you, then they laugh at you, then they fight you, then you win."
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In today's New World I will tell you exactly how I think you can win by investing in the most thriving economies of the next decade.
'All those countries not yet developed'
Most investment professionals follow the definition offered by the Morgan Stanley Capital Index (MSCI) which classifies it as consisting of indices in 21 emerging economies (EM): Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
Within the MSCI EM Index the biggest country weightings are China (17.8%), South Korea (14.6%), Brazil (11.9%), Taiwan (11.6%), South Africa (6.8%) and India (6.6%).
Two huge milestones for emerging markets
On 25 December 1991, the world watched with bewilderment as the Soviet Union split up into 15 separate countries. It was widely seen as a triumph for democracy and Western liberal economic policies. The Cold War came to an end, resulting in a cascade of economic reforms ripping through emerging markets in Asia, Africa and Latin America. But perhaps most important of all, a couple of billion new low-paid workers were added to the global work force.
On 11 December 2001, after 15 years of arduous negotiations, China finally joined the World Trade Organisation (WTO). It led to a stupendous economic growth phase, underpinned by large foreign direct investments, restructuring and listing of leading state-owned enterprises and the transformation of China as the world's leading exporter and second biggest importer.
How have the world's stock markets performed since then?
From the first milestone (1991), the FTSE has yielded an annualised return (all in US dollar terms) of 4.0%; the S&P500 yielded 7.0%; and the MSCI EM 6.5% (but with a wide difference within the group: India 11.6% and China 5.5%).
From the second milestone (2001), the FTSE gained 2.9% per year: the S&P 500 3.2%: and MSCI EM 11.0% (India 14.5% and China 15.6%).
Emerging markets have outperformed the UK by far over both periods and tracked/exceeded the US in the short-run. Hence it seems premature to write them off as fairy stories. Hard facts suggest the opposite.
What really matters is the performance in the long run.
112 years and counting
What is interesting is that the top three were all outside Europe and could loosely to be defined as former emerging markets: Australia (7.2%), South Africa (7.2%) and the US (6.2%).
For Europe the performance is mixed. UK yielded a respectable 5.2%, but the heavyweights Germany and France offered a paltry annualised return of 2.9%. And even more worrisome, returns for bonds and bills were negative for both the former countries.
And for those of you who fancy a punt on Italy, caveat emptor! The long-term real return on Italian equities was an annualised 1.7% as compared to bonds and bills, which gave a real return of 1.7% and 3.6% respectively.
The final stage in the Gandhi treatment
My optimism hinges on three observations.
Firstly, the New York Stock Exchange started in 1792 at a time when Dutch and UK bourses had been operating for more than a hundred years. Since then the US stock market has gone from zero to over 45% share of the world's stock markets. Extrapolating from such a successful market could lead to "success bias" warns Credit Suisse. To only focus on the 1997/98 Asian Financial Crisis or the problems in China is a "failure bias".
Secondly, the institutional differences between emerging and developed markets are narrowing. A lot of experts tend to use poor institutions' as the main justification for why emerging markets deserve to trade at a discount to their more developed peers. I think this is gradually becoming obsolete. BoA Merrill Lynch points out that EM central banks have become more technocratic in the past ten years, and have increasingly adopted inflation targeting (IT) as their preferred monetary policy framework. Of the 26 central banks studied, 19 had adopted, either explicitly or implicitly the IT target. It has resulted in the EM average lowering to 6.4% (2003-12) compared to 32.7% in the ten previous years. And according to Reinhart and Rogoff, there were four banking crises from 2003-2012, compared to 38 in the ten previous years.
Thirdly, we should be humble and realise we live in extraordinary times. The economic historian Angus Maddison in his magisterial The World Economy: a Millennial Perspective (OECD, 2001) reminds us the world grew by annual average compound growth rate of 0.01% for the period 0-1000, 0.22% between 1000 and 1820 and 2.21% from 1820 to 1998 (the start of the industrial revolution).
I believe that future growth will tilt to emerging markets where the need for goods and services is the biggest. Just as Japan flourished in the 1980s as the country entered a consumption based economy I believe the ASEAN countries are about to experience a similar path. And any companies located there should look forward to many opportunities to capitalise on this fundamental change. With ten member countries soon to become a global economic pivot point and a combined economy worth $2.5trn, it would be crazy to ignore or write off this exciting region.
All told, I'm still flying out the flags for emerging markets.
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