Are emerging markets set for a recovery after sliding by around 15% over the past few weeks? Most analysts canvassed by Germany’s Handelsblatt last week were bullish, pointing out that emerging economies are in sound shape. Having paid down debt, amassed foreign-exchange reserves due to the commodities boom, and lowered budget deficits, emerging economies are less dependent on foreign capital flows and unlikely to slide into crises as they did in the 1990s. Fundamentals are sound and blowing off the froth on the market has reduced average p/e ratios from around 12 to ten.
But not everyone is so optimistic. Merrill Lynch notes that measures of risk appetite, such as emerging-market debt spreads and the VIX Volatility index, have yet to stabilise, while a forthcoming US slowdown is another reason for caution. As a result, emerging markets look likely to underperform rival asset classes amid a consolidation lasting into the autumn. So this may not be the best time to rush into emerging markets, but it seems worth keeping some in mind for when the dust settles.
One such is Korea, which remains among the “most attractive” growth opportunities in Asia, according to Merrill Lynch’s Namuh Rhee. The economy expanded by 6.2% year-on-year in the first quarter and solid consumption should offset slowing exports. Ongoing cost-cutting should help earnings growth recover later this year, while the market trades at a 20% discount to the region on a p/e of 11.6.
However, the key point is the emergence of a long-term equity culture. Korea has been able to tempt local investors into the market by introducing regular savings plans, whereby investors put a monthly sum into equity investment trusts. Local monthly fund flows have remained broadly steady of late – while foreigners bailed out – and should continue to underpin the market. The importance of local investors compensated for net foreign selling last year and led to a re-rating of the market, says Garry Evans of HSBC. This process has further to go.