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2013 a Year in Global Emerging Markets - Schroders Outlook

2013 a Year in Global Emerging Markets - Schroders Outlook

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Published by: blacksmithMG on Feb 03, 2013
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We expect emerging marketequities to deliver solidperformance during 2013and perform even betterover the longer term.Emerging markets look extremely attractive in termsof valuations.We believe the Chineseeconomy has stabilised andwill see a modest recoverynext year and that tail risksin the developed world havebeen reduced for now bycentral bank policy.
Despite the fact that there has been little progress in resolvingthe underlying structural issues in the developed economies,2012 has been a decent year for risk assets. Both developedand emerging equity markets have delivered reasonablereturns against a difficult macroeconomic background.The MSCI World Index is up 13.7% year to date (as at 30November) and the MSCI Emerging Markets Index is up12.7% (both in US dollar terms). Over the last three monthshowever, emerging returns have been stronger with theMSCI Emerging Markets Index up 6.7% versus theMSCI World Index which is up 3.4%.
 This is a good result given the degree of uncertainty about global growth and the cleartail risks that exist. In particular, Europe has made little progress in terms of dealing withits sovereign debt issues or the major balance of payments problems and the disparityin competitiveness that exists between member states of the eurozone. Moreover, theUS has been hindered in addressing its budget deficit by the presidential election andpartisan opinions on the trade-off between tax increases and entitlement reductions.Finally, the slowdown in Chinese growth over the last year or so has resulted in elevatedconcerns that the economy will suffer a hard landing.What has clearly helped however, is the continued support in terms of abundantliquidity and other measures provided by central banks. Specifically, the US FederalReserve announced its third round of quantitative easing (QE3) during September andarguably we will get ‘QE infinity’ if growth remains weak and unemployment stays high.In Europe, Mr. Drahgi announced in late July that the ECB would “do whatever it takes”to save the euro and followed this with the Outright Monetary Transactions (OMT) bondbuying programme announcement in September. These measures have helped containperipheral bond spreads and support equities.
2013: Continuation of “muddle-through”
So what does this mean for global emerging markets (GEMs) next year? In alllikelihood we will get a continuation of the muddling through and more of the same forequity markets. In other words, anaemic developed world economic growth (but muchstronger emerging activity), plenty of liquidity, record low interest rates and generallypositive equity markets. However, there is likely to be much dispersion of returns betweenmarkets, punctuated by periods of tail-risk uncertainty. In terms of the economic outlook,we expect the US to deliver around 2% GDP growth next year, the eurozone to shrink afurther 0.3% but GEMs to experience a modest increase in GDP from around 4.7% thisyear to approximately 5.2% in 2013.
GEMs to perform well in 2013
More specifically, we expect emerging market equities to deliver solid performance during2013 and perform even better over the longer term. There are several reasons for this.
For eligible charities onlyDecember 2012
 Allan Conway, Head of Emerging Market Equities, looks ahead into 2013
2013: A year in global emerging markets
Outlook2013: A year in global emerging markets
In all likelihood we willget a continuation of the muddling throughand more of the samefor equity markets. Inother words, anaemicdeveloped worldeconomic growth (butmuch stronger emergingactivity), plenty of liquidity,record low interest ratesand generally positiveequity markets.”
First, taken in isolation, GEMs look extremely attractive in terms of valuations, bothabsolute and relative to history as well as on a market capitalisation to GDP basis.For example, the forward price-earnings ratio (PE) for GEM currently stands at around10 times, compared to an historic forward multiple of above 12 times.
MSCI EM 12-month forward PE
Source: Schroders, FactSet, IBES, MSCI, data shown to September 18, 2012.
Moreover, in terms of market capitalisation to GDP, emerging markets are trading at morethan one standard deviation below the historic average (see below). This measure hasusually been a very good indicator of long term over- or undervaluation.
GEM aggregate Index to GDP
Source: UBS, data shown to August 31, 2012. Past performance is not a guide to future performance.
Second, two of the three most significant headwinds for risk assets in 2012 should beginto fade as we progress through next year. Specifically, Chinese economic growth appearsto be responding to the modest easing measures that were implemented earlier thisyear. Third quarter GDP growth was up 7.4% year on year and there were signs that theeconomy was gaining momentum in the second half of the quarter. In particular, exports,consumer spending and leading indicators all suggest that the third quarter may havemarked the bottom in terms of economic activity.
681012141618202219941997199920022004200720102012MSCI EM 12m Forward P/E Average
050100150200250300Dec 88 May 92 Oct 95 Feb 99 Jul 02 Nov 05 Apr 09 Aug 12GEM Aggregate Index/GDP AVG +1STD -1STD-57%-54%+121%+396%+342%-65%+154%% moves in the MSCI EM Price Index
Outlook2013: A year in global emerging markets
 This is further supported by the most recent fourth quarter data and by the apparentstabilisation of the property market, as shown in the charts below.
Price moves in 70 key Chinese cities
Source: Schroders. Thomson Datastream. Data to July 2012.
China property historical inventory months: Tier 1 Cities
Source: Morgan Stanley Research, Soufun. Data to July 31, 2012. Past performance is not a guide to futureperformance.
With inventories in many areas of the economy back to more normal levels and a newleadership about to take over in China, there is a strong possibility that concerns overa hard landing for the economy will fade early next year.We will also have a resolution to the US ‘fiscal cliff’ debate early next year. Our base caseis that a compromise will be reached, even if it goes to the wire, and that the fiscal dragnext year will be around 1.5% of GDP. This should translate into overall growth of around2% in 2013. Whether this turns out to be correct remains to be seen, but at least theuncertainty created by this issue will be largely removed in the near future. The one remaining major overhang for markets is the eurozone crisis. In our opinion,this continues to represent the biggest risk for equity markets, including GEMs. Asmentioned above, we are assuming a muddle-through scenario which means Greecestays in the eurozone, Spain asks for and receives a bailout and the eurozoneexperiences a mild recession.
0102030405060Jul 12Jun 12May 12 Apr 12Mar 12Feb 12Jan 12Dec 11Nov 11Oct 11Sep 11 New Build Price Declines (m/m)Number of CitiesNew Build Price Increases (m/m)
GuangzhouShenzhenShanghaiBeijing 01020304050Jul 12Sep 11Oct 10Nov 09Jan 09Feb 08Mar 07May 06

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