Can Emerging Markets Defy Gravity?

New CIR Online Debate asks whether emerging economies can overcome the past.

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1288212_swingSince the crash of 2007, equity returns have generally been muted – except for emerging markets and countries exposed to them, such as Canada and Australia.

Are these markets defying gravity? Arguably not. They have strong balance sheets and growing economies with rising middle classes and an increasing consumer focus to supply an urbanizing population.

Yet emerging economies remain a small part of most investors’ portfolios. Memories of 1994 and 1997 and 1998 – when emerging markets were upended by crashing currencies – remain strong.

Have emerging economies overcome the past?

That’s the proposition up for debate on Canadian Investment Review Online Debates: “Emerging market equities offer a superior investment opportunity with regard to developed markets.” The debate is sponsored by Pyramis Global Advisors.

“Emerging markets have continued to increase in importance in the discussion on the global economic landscape,” notes guest moderator Adam Bomers, director investment research and solutions at Aurion Capital Management Inc. There is some evidence that emerging markets have decoupled from the debt crisis of the developed world. But there are risks. “Is there an opportunity for investors in emerging markets relative to developed markets or has our optimism created yet another asset bubble?” he asks.

It’s not quite a bubble, argues Paul Kapsos, a portfolio manager at Ontario Teachers’ Pension Plan.

“Despite growth deceleration and increasing competition, corporate cash flow will grow more rapidly compared to developed markets, with higher incomes driving services and goods demand and creating business opportunities,” he says. “In addition, demographics, rising incomes and widening tax bases will give emerging market governments greater relative flexibility, while entitlements and debt limit developed market fiscal options, leading to rising tax rates. I would expect that emerging market growth will decelerate less, leading to higher relative cash flow growth and equity market outperformance.”

For that reason, he expects incremental rewards from emerging markets.

But Mark Williams, executive-in-residence and master lecturer at the Boston University School of Management takes the opposite view. “Yet this sector has been priced for perfection and many risks ignored,” he says. Moreover, emerging markets are not immune from developments in advanced economies.

“Globalization has elevated the level of systemic risk as developing and emerging market economies are increasingly interconnected,” he says. “This linkage has created a global chain of countries (big and small) that are impacted by the economic strength or weakness of each other. A country default in Argentina can have a ripple effect in Morocco. In the modern world economy, it is a fatal investment error to assume that a single country will not be impacted by events of another country.”

To join the debate, go to CIR Online Debates.

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