Emerging markets volatility - not all bad | BetaShares

Emerging markets volatility – not all bad

BY betashares | 11 February 2014
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Currently, emerging market shares and bond prices are generally experiencing increased volatility and falling prices. Although this is a direct result of tapering by the US Federal Reserve, it is also a healthy sign markets are starting to focus on investment fundamentals – and measured by these standards, many emerging markets don’t pass muster.

Currently, emerging market shares and bond prices are generally experiencing increased volatility and falling prices. Although this is a direct result of tapering by the US Federal Reserve, it is also a healthy sign markets are starting to focus on investment fundamentals – and measured by these standards, many emerging markets don’t pass muster.

This is another sign that markets are moving out of their post-GFC phase and back to a world where investment returns are somewhat more rational and soundly based. That is likely to mean at least two things that investors can potentially benefit from in the near term:

  • The withdrawal of capital from emerging markets, and its return to major developed markets like the US, should provide positive momentum to the US$ and to US financial markets;
  • The reduction in the levels of “hot” money from the Australian market should take some of the heat out of Australian share prices, and is likely to create buying opportunities as corporate earnings improve.

Investors can access these opportunities through the BetaShares U.S. Dollar ETF (ASX code “USD”), which provides exposure to the performance of the US$ v. the A$ and the BetaShares FTSE RAFI Australia 200 ETF (ASX code “QOZ”), which provides exposure to the largest 200 stocks on the Australian market, as measured by ‘fundamental value’.

What’s “wrong” with emerging markets?

To understand what’s wrong with emerging markets, let’s take a quick look at what made them so attractive to investors after the GFC. Apart from the overall perception that emerging market assets would rebound in value after dropping so significantly during the GFC, the low cost of production and the abundance of natural resources in many emerging markets attracted foreign investment, which in turn increased economic activity, GDP and corporate earnings.

Now, five years after the onset of the GFC, these markets are being punished for a variety of economic “sins”, which may be grouped into four major categories:

  1. Economic mismanagement in economies like Argentina and the Ukraine has made these countries less attractive from a sovereign risk perspective;
  2. Domestic growth levels in highly leveraged countries like South Africa and Peru are beginning to slow, as interest rates rise and debt servicing costs increase;
  3. Countries like Hungary with fragile banking systems remain exposed to the ongoing repair of the financial system in the Eurozone;
  4. The BRIC countries are still working through the problems of domestic structural problems – in the case of China, for example, these problems include an overextended banking system, potential housing bubbles, inflation and demographic problems.

What does this mean for Australian investors?

As the global economy re-aligns, and as capital rotates from emerging markets and back into key developed markets, the emphasis for investors will be to focus on the fundamental aspects of share price valuations like earnings and earnings growth, sales, profitability and gearing ratios.

Whereas immediately after the GFC it was difficult to have confidence in data, as stability returns it is more possible to do so. The days of making “easy” money by investing in emerging market economies that were less exposed to the GFC are now being replaced by asset price growth driven by sounder and improving fundamentals.

Australian investors are now re-focusing on international share markets such as the USA, Japan, the UK and Europe, although there is perhaps some more time needed before profitable investing opportunities emerge in the latter two.

So rather than being a cause for alarm, we believe the re-alignment of  EM economies and the rest of the world opens up some fascinating opportunities for Australian investors.

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