26 October 2016
Emerging markets, such as Indonesia, may now be worth a closer look. Photo:
Emerging markets, such as Indonesia, may now be worth a closer look. Photo:

Why investors should focus more on emerging markets

The long-awaited US rate hike will bring volatility for local equity and bond markets.

However, equities in the eurozone and Japan remain attractive in the light of quantitative easing, and emerging markets are also interesting at low valuations, Stefan Hofrichter, head of global economics and strategy for Allianz Global Investors, said.

The global economy is poised to post modest growth. Neither the US nor Europe will follow the economic meltdown suffered by Japan in 1980s.

Various countries have adopted a very loose monetary policy since the financial crisis, on a greater scale and at a faster pace than Japan did.

Also, the leverage ratios of European and US companies is much lower than those of Japanese companies at that time.

Therefore, the deleveraging move will have a milder impact on the economy.

In addition, the housing market in the United States and some European countries has already shown signs of recovery, which would help shore up the balance sheets of households and accelerate the uptick of the banking system.

By contrast, Japan has gone through property price declines for nearly two decades.

However, global economic growth will remain subdued in the years ahead.

Europe and the US are no longer able to rely on strong growth in exports.

Meanwhile, emerging markets, once the growth engine for the global economy, are struggling with slower growth, weaker productivity and excessive debt for households and firms.

And investment activity in developed economies, in particular in R&D, is disappointing.

Companies are reluctant to expand investment despite large cash flows.

Their hands are tied given a fragile economic recovery, tightening regulation and political uncertainties.

And debt-laden countries like Spain and Portugal continue to adopt austerity policies, which stifle the private sector.

Meanwhile, interest rates in the developed world have come close to zero, which stirs up prices for various asset classes, especially high-risk assets like equities.

However, it remains questionable how that can stimulate the real economy and boost investment for more than one year.

The timing of the first rate hike by the US Federal Reserve is critical for the price movements of various asset classes.

The US labor market has shown strong recovery, which makes the first rate hike very likely to be this summer.

However, the minutes of the Federal Open Market Committee revised the projected interest rate at the end of 2017 down by 60 basis points (0.6 percentage point) from the previous projection.

That indicates that the prospects for economic growth might be a bit bumpy going forward.

The market has expectations similar to those that led to the adjustment by the Fed.

The synchronizing of expectations is very important.

If the market expects an earlier date for the rate hike, it would trigger a sell-off for US government bonds; in particular, short-duration bonds.

And the long-duration bonds are not safe, either, given their already high valuations.

The valuations for European and Japan markets remain reasonable according to the Shiller P/E ratio.

Asset prices in both regions will be supported by monetary easing measures and weak currencies.

However, the weak Japanese yen has affected the competitiveness of some Asian exporters.

And commodity exporting countries in Asia are also suffering from low energy prices.

Generally speaking, there is an abundance of value investment opportunities in emerging markets thanks to weaker currencies and loose monetary policies.

Investors should return to emerging markets in the medium and long term while being wary of market volatility in the US.

This article appeared in the Hong Kong Economic Journal on May 18

Translation by Julie Zhu

[Chinese version 中文版]

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Chief Investment Officer at Allianz Global Investors, Asia Pacific

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