![Devan Kaloo sees opportunities for investors prepared to look past economies with unorthodox monetary policy.](/content/dam/images/g/r/s/3/9/h/image.related.afrArticleLead.620x350.grsf47.png/1475582620557.jpg)
Economic growth is returning to emerging markets on the back of orthodox monetary policy, which stands in stark contrast to the intractable mess developed markets find themselves in. This orthodoxy is beginning to pay off.
Having raised interest rates and endured austerity to tame inflation, emerging market central banks positioned themselves to cut rates again and restart growth, which has led bond prices to rally. As yields have fallen equities are also rallying, driving fund inflows and leading currencies to rally too.
After working through recessions, both Brazil and Russia are forecast to deliver positive GDP growth in 2017 for the first time in years. Importantly, the trigger for this resurgence in emerging markets is not a rebound in commodity prices, but rate cuts in response to falling inflation. It underlines the sustainability of this recovery trend.
Moreover, even as the US Federal Reserve stands ready to embark on a series of interest-rate hikes – traditionally a source of painful volatility for emerging markets – this cycle is widely expected to be gradual and controlled. The June 23 vote by the British public to leave the European Union increased political and economic risks, suggesting global monetary policy will be loose for longer.
This has weakened the case for US rate rises and should be supportive of emerging market equities and currencies.
Better placed
Certainly we don't expect the European Central Bank, the Bank of Japan, the Bank of England and the People's Bank of China to raise rates anytime soon. But we strongly believe countries such as Brazil, India, Indonesia and Mexico will continue to cut rates. Underscoring this decoupling, developing nations are better placed to cope with US rate hikes and a strengthening dollar than in previous years, given that most now have flexible exchange rates and ample foreign exchange reserves.
The markets we favour from a portfolio perspective include Hong Kong, India, Mexico and Brazil. Hong Kong offers diversified, regional businesses, particularly those providing exposure to mainland China, with the added advantage of better standards of accounting and transparency. India's new tax bill is expected to boost investor sentiment and export competitiveness.
The country is home to high-quality companies with good, long-term prospects. Mexico also offers many well-run firms at attractive valuations that are in line to benefit from the government's reform agenda. It is a similar story in Brazil, where the new government is restoring confidence and seeking to accelerate the liberalisation of various industries.
Sprawling conglomerates
Countries we have reservations about including China, with its substantial and growing debt burden. We foresee a continued decline in corporate profitability there. Besides, most of its companies still fall short on quality and corporate governance. We are also underweight to South Korea.
The domination of chaebol, or sprawling conglomerates, can make the business landscape less competitive; moves to prevent hostile domestic takeovers have also raised concerns. Additionally, while Taiwan is home to several interesting businesses, the bulk of them are in lower-quality cyclical industries and corporate transparency is generally poor.
From a sector perspective, our underweight to technology is due largely to characteristics that embody the segment, such as cyclicality, constantly evolving business models and increasingly shorter product lifespans. We are also underweight to industrial companies, which tend to be more aggressive in balance-sheet management, and utility companies because of regulatory risk.
As for the companies we do hold, we are positive about what we are seeing on the ground. They have reported decent results, particularly those outside of the commodities sector. We are seeing evidence of margin expansion and growth in earnings denominated in local currencies, with scope for significant earnings in dollar terms to come in the year ahead.
Devan Kaloo is head of Global Emerging Markets, Equities, Aberdeen Asset Management