Just in time for Morningstar.co.uk’s Global Emerging Markets Week, HSBC Global Asset Management yesterday announced a major milestone as assets under management in emerging markets breached $100 billion as at the end of September, making the region represent almost a quarter of the asset management firm’s total AuM ($444.6 billion).
HSBC continues to believe that the emerging markets offer substantial opportunities and in a recent 2011 Market Outlook Philip Poole, Global Head of Macro and Investment Strategy at HSBC Global Asset Management, urged investors to seek return from emerging markets financial and real assets, while selecting commodity-based currencies and assets in the developed world.
Writing in a strategy piece aimed at professional investors, Poole repeated the popular story read aloud by portfolio managers and economists of late, that the developed markets are set for subdued returns but emerging markets are expected to continue to achieve impressive economic growth rates and corporate earnings.
However, stock market returns are not strongly correlated with real economic growth, Poole noted as he points to the importance of focusing on what valuation multiples buy in terms of expected future earnings growth. On HSBC’s calculations, within the emerging markets arena Russia and Abu Dhabi look relatively cheap on equity valuations versus forecast earnings growth, while Chile, Colombia, Philippines and India are relatively expensive. In contrast, Italy and Spain look relatively cheap amongst the developed markets and Canada and Sweden appear to be fairly pricey.
“In terms of the major emerging equity markets, Russia looks cheap relative both to its own trading history and to peers while India is relatively stretched on both counts, as is Indonesia,” wrote Poole. “China and Brazil appear more fairly valued.”
There is a dark side, however, to the current dichotomy between emerging and developed markets: the negative impact of loose monetary policy in the developed world for emerging economies and the risk posed by inflation in the latter.
“In general, the risk here seems to be biased to the upside, particularly in emerging markets where the combination of food price inflation, currency intervention and tightening capacity constraints looks set to keep inflationary pressures front of mind,” Poole wrote. Not only will such inflation affect investor returns but it could also feed back to developed markets. “While the developed world is likely to be characterised by deflationary not inflationary pressures, the impact of inflation in emerging markets could eventually feed through to DM via higher prices for imported commodities and goods and services and via the long-term impact of QE.”
Poole neatly summed up the cause and effect of further QE encouraging further asset flows to emerging markets:
“As many emerging markets policy makers have recently pointed out, QE2 is less a policy of ‘beggar thy neighbour’ than overload him with ‘too much of a good thing’. With ultra low rates, additional QE anchoring (at least parts of) the yield curve and developed world growth expected to remain generally anaemic, much of the Fed’s liquidity wave is likely to wash straight out of the US economy in search of yield and growth in climes that now look much sunnier even than Californ-I-A. Central banks should tighten monetary policy in response but it’s Catch-22. Raising policy rates in this environment only increases the attraction of owning emerging currencies, potentially aggravating not dampening asset bubble risks.”
Given the challenge that emerging markets face of attempting to absorb rising inflows and nurture domestic demand without triggering a new boom-bust cycle, HSBC’s Poole believes it’s paramount that investors buy some protection from the resulting risk of emerging market inflation via exposure to inflation-linked bonds. Poole notes, however, that HSBC’s quantitative models suggest that developed markets inflation-linkers look rich right now, so investors face their own challenge of finding inflation protection that’s still affordable.
Catch up on more content from Global Emerging Markets Week.
