Emerging market equities remain one of the best sectors for long-term performance, says a global investment strategist for one of the world largest institutional investment firms. Possibly even more important for investors, the volatile nature of the asset class is expected to decrease over the long term.
George Hoguet, managing director and global investment strategist specializing in emerging markets for Boston-based State Street Global Advisors (SSgA), was in Toronto on Thursday, giving pension managers and consultants an overview of the emerging markets. He says that despite the phenomenal returns and decreasing volatility in emerging markets, many managers are still shy about investing in them.
Hoguet suggests that investors of all stripes create a global asset allocation benchmark and invest strategically—buy and hold—in emerging markets, taking a top-down view.
“Emerging market equities can almost be viewed as a call option on world growth,” he says. “What we really have to think about is what the world looks like while we are moving forward; there are some secular drivers. First of all, China’s economy is now larger than Germany. Twelve years from now, it’s expected to be larger than Japan, and if you look at a straight line projection, by 2045 China is larger than the United States.”
There are other fundamental factors that position emerging economies for long-term sustained growth, including younger demographics to fuel innovation and labour supply and—for the two most high-profile emerging economies, China and India—relatively low dependence on the U.S. and other Western economies.
“What drives equity prices in the long term are real earnings per share growth net of issuance, and real earnings per share growth tracks long-term GDP growth,” he says.
In the intermediate term, emerging economies are growing more rapidly, and therefore earnings per share are growing more rapidly, Hoguet says. Many investors likely realize this, but risk has been a deterrent—something Hoguet doesn’t dispute.
He says there is concern by market observers that emerging market economies may stall under the weight of higher commodity prices, similar to the North American market in the 1970s.
“Since the inception of the emerging market equity index in 1988, emerging markets have substantially outperformed Canadian equities—particularly over the past five years,” he says. “There is the prospect of slowing productivity growth. If you look from 1969 to 1982, the Dow Jones did nothing; it was essentially flat. Are we going back to this period of stagflation? What accompanied the oil shock of the 1970s was a significant drop of productivity, not just in the United States but in Europe and Japan. That seems to be the real question for investors [in emerging markets].”
For some emerging markets, like Brazil, the commodity boom will be a boon; for others, like China, it could dampen growth.
There is also the question of whether a sagging U.S. economy will take a bite out of earnings. In both circumstances, Hoguet expects slower growth for countries like China in the near term, but eventually—like the North American economies did in the 1980s—he expects them to adapt.
“I think that supply and commodities will become unstreamed, but it can take many years to do that. Look at the price of oil in the 1970s. Oil in real terms peaked in the late 1970s, but in the 1980s the industry laid off people by the thousands because new supply came online,” he says. “The same thing is going to happen in terms of new product for things like copper, tungsten, etc. That’s probably going to take about five to seven years to happen. If there is a sharp drop-off of commodities, China will be a winner and Brazil will be a loser. If it’s associated with a global recession, emerging markets in general will be very negatively impacted.”
Emerging economies in Asia do have some significant external risk protection in that they have largely decoupled from U.S. demand. It’s domestic growth that’s fueling their rise.