Why this could be the right time to buy emerging markets equities

In these times of high volatility and risk aversion, some people may find it foolish to buy emerging equities which are traditionnally considered as "high beta" risky investments.

It may seem a bit contrarian indeed, but I am not the only one to hold this view. Seasoned investors like Mark Moebius who manages 34 billions USD of assets at Templeton Asset Management are more bullish than ever on emerging markets (see video above).

Emerging markets have performed poorly this year

So far, it is true that emerging markets have suffered more than developed markets from the general flight to safety away from risky assets. As a matter of fact, on a year-to-date basis, the iShares MSCI Emerging markets ETF index (NYSE:EEM) dropped a whopping 39% compared with a drop of "only" 25% for the iShares S&P 500 ETF Index (NYSE:IVV) !

In addition, there is now a widespread feeling that the worst is yet to come for the global economy, as economic data clearly shows the United States, Europe and Japan have either entered into recession or are on the brink of it.

As investors around the world try to find out where are the next victims of the global credit crunch, one big question mark lies on the so-called BRIC countries (Brazil, Russia, India, China) which have alltoghether accounted for two thirds of global growth over the last five years (on a PPP basis).

So, is it just a matter of time before these economies falter and fall into recession ? For me, the answer is NO.

Why emerging economies will not fall into recession

With all the gloom and doom coming from Wall Street it is very difficult to keep one's nerves. If stock markets were a good predictor of developments in the real economy than we should really worry, as stock markets in the BRIC countries lost between 40% and 50% of their market capitalization in just a few months.

Actually, stock markets are NOT a good predictor of the real economy as far as emerging markets are concerned. At short time horizons, these markets are in fact much more influenced by the US stock market than by developments in their domestic economy. Call it financial integration or call it contagion it does not matter. This owes simply to the hegemonic nature of the United States which still account for 26% of the world GDP and 34% of the world market capitalization as of september 2008 (down from more than 50% five years ago).

The true story is that of a gradual decoupling between developed and emerging economies. The former are now going through a painful deleveraging cycle after having lived for many years"beyond their means". In sharp constrast, the latter are witnessing an unprecedented boom with domestic demand soaring thanks to massive investments in infrastructure, a construction boom, and an incredible consumption frenzy .

Don't mistake me, I am not saying that everything is rosy for emerging markets. Many export-led emerging economies will be impacted in a way or another by a recession in the developed countries. However, this impact should be cushioned by the growing South-South trade between emerging countries themselves. Hence, Russia and Brazil will continue to import manufacturing goods from Сhina and India which will in turn continue to buy commodities from the former to satisfy their huge thirst for energy and basic resources.

Some good reasons for investing now in emerging markets

Although the earning prospects of some companies based in emerging markets may be negatively impacted in the short term by slowing orders from the US and Europe, this provides them with an incentive to increase their productivity and to move up the value scale. As an example, Wen Jiabao, the Chinese Premier urged last week chinese manufacturing companies to invest more in innovation and to export more products under their own name, rather than just being low cost contractors for western companies. The same is happening in India, as the battle for Axon illustrates it, with indian outsourcing companies increasingly looking to expand beyond their borders, and to deliver high value-added services.

Another good reason for being bullish on emerging countries comes from the fact that they have been relatively well preserved from the global credit crunch. Indeed, most emerging economies are awash with cash, with large foreign exchange reserves and well capitalized banks which have developed overstretched investment banking departments, and have not invested in the kind of toxic securities that brought down to its knees the entire US financial system.

Finally, if you look at equity valuations, given the tremendous growth potential of these economies that still lies ahead, the current valuation of hundreds of blue chips companies from Turkey, Russia, China, or Brazil have never looked as attractive as now ! And although the MSCI Emerging Markets is down 39% this year it is still up by more than 93% from its level five years ago !

For all these reasons, this is the right moment to buy excellent assets at bargain prices, with the intention of holding them for 5 to 10 years.

Alex Kateb

This article has been published on Seeking Alpha, a leading investment website, at the URL http://seekingalpha.com/article/98662-why-now-could-be-the-right-time-to-buy-emerging-markets-equities