Emerging Markets: Cheap or Good Value?

There is a difference between “cheap” and “good value” – which best describes the current state of emerging markets?

(February 28, 2013) — Emerging market share prices have fallen back to 2002 levels, but investors should not take this as a sign to dive straight in, analysts at Deutsche Bank have said.

While valuations appear similar at an aggregate level, a note from the bank said this week, the underlying fundamentals are very different.

“In 2002, following a series of economic and financial crises, there was a positive shift towards capital-friendly economic policies and corporate governance taking place across most of the emerging market universe, which had gone almost completely unrecognised by investors,” the note said.

Between 2003 and 2007 a bull run produced a 450% rise emerging markets, but few investors took advantage, Deutsche Bank said. This was due to an aversion to the unknown and a reliance on past performance as a guide for future investment.

A decade later and investors are much more open to the idea of investing in these markets, the bank said, despite conditions being no better – and in some cases worse – than before.

“By contrast today, the situation has reversed with no visible improvement in corporate governance in privately controlled companies and a pronounced tendency across the BRICS in particular, for increasing levels of state intervention to the detriment of minority investors, with the partial exception of India.”

The analysts said that practically all of the cheap sectors and stocks had fundamentals that were visibly deteriorating.

This month a survey of UK investment professionals found emerging market equities are seen as being undervalued. The CFA Valuation Index found just under half of respondents viewed emerging market equities as being undervalued or very undervalued, up from 43% in the first quarter of 2012. In comparison just 22% believed this month that emerging markets were overvalued compared to 27% in a year ago 2012.

A counterpoint to the Deutsche Bank argument was made by Jan Dehn, co-head of research at emerging markets specialist Ashmore Investment Management.

In an outlook note for the year, he estimated emerging markets to grow 6% in 2013, up from just over 5% in 2012, and to continue at a similar pace for at least a few years. This prediction was made against a backdrop of better global financial and economic activity and a pick-up in global manufacturing.

“As 2012 showed, emerging markets do not rely on strong highly indebted countries’ [developed markets] growth to have strong growth of their own. The bulk of growth in emerging markets is due to domestic factors. Emerging markets are not saddled with excessive debt loads, a number of countries are undertaking significant reforms, and last year’s monetary easing in many countries should bear fruit this year in terms of higher growth,” Dehn said.

To read the Deutsche Bank analysis, click here.

To read the Ashmore Investment Management analysis, click here.

Related content from April 2012: Is Emerging Market Debt This Year’s Junk Bond?