5 reasons emerging markets are better positioned to deliver growth
While market falls can be unsettling, they can present unique investment opportunities. The key question is which markets will deliver growth from now on - and we believe it is a compelling time to consider emerging markets equities.
1. Orthodox monetary policies
It may surprise UK readers to know that policies in emerging markets have generally been more orthodox and conventional than developed markets recently. We believe this has led to more robust economies relative to their own history - and relative to developed markets.
Since the global financial crisis in 2008, emerging economies avoided experiments with negative interest rates. And during the recent pandemic, policymakers in emerging markets generally did not pursue overly aggressive fiscal support plans, which means they did not blow up their balance sheets.
This contrasts starkly with developed markets like the United Kingdom, for example, which has enacted very aggressive fiscal expansions and a disastrous economic experiment that, most recently, led to Liz Truss’s doomed 45-day premiership and market turmoil.
2. Dealing with inflation
Inflation has accelerated post-pandemic but many emerging economies were pre-emptive in tightening interest rates and dealing with inflation. The United Kingdom, the eurozone and the United States are wrestling with runaway inflation – it breached 10.1% again in the UK this month – the highest in 40 years as the country’s cost of living crisis continues.
Inflation at 10.1% in September 20221
Consumer Prices index.
In contrast, many emerging economies have already completed their tightening cycles. Brazil, for example, started tightening in March 2021, and has already made 12 consecutive rate hikes to prudently manage the situation. Inflation has been decelerating there in recent months and the central bank to pause its hiking cycle in September. The US Federal Reserve, meanwhile, did not start raising rates until March of this year – which many feel was too late.
3. Lower debt burden
In addition, emerging economies are typically less indebted at the sovereign, corporate and household levels. In Mexico, for example, the household debt-to-gross domestic product (GDP) ratio is 16%, compared with the United Kingdom’s ratio of around 90%.2
Relatively Low Debt-to GDP Ratios in Emerging versus Advanced G20 Economies
Debt (General Government Gross) to GDP Ratio*
*Weighted Average based on PPP (Purchasing Power Parity) GDP Weights; as of August 8, 2022. Argentina is excluded from emerging economies due to non-availability of forecast. Calculations by Franklin Templeton’s Global Research Library with data sourced from FactSet, International Monetary Fund. Important data provider notices and terms available at www.franklintempletondatasources.com .
4. Attractive valuations
In addition, emerging market equity valuations are trading at near historic discounts versus the developed world. In our analysis, the relative profitability between these two asset classes does not warrant the current 45% discount.3
And relative to its own 15- to 20-year history, emerging markets as an asset class is one of the few that looks cheap to us. The MSCI Emerging Markets (EM) Index, a benchmark representing the asset class, is now trading at close to 10 times forward earnings of its constituent companies, compared to around 18 times for the US S&P 500 Index (S&P 500).4
5. Dividends and buybacks show corporate strength
As a sign of corporate health and balance sheet strength, many emerging market companies have been increasing their dividend payouts. They have been using their cash flows to distribute dividends to shareholders rather than deploying capital in such an uncertain growth outlook.
Company managements have also been seeing value in their equities, resulting in increased share buyback activity. In this volatile environment, however, these dividends and buybacks are appreciated by shareholders, but we do prefer companies invest in their own businesses over the long term to generate growth and strengthen their competitive position.
While we believe the persistence of high dividend levels is unlikely to remain at the current 4% level, there has been a sea change in how emerging market companies think about capital optimisation and balance sheet management.5 Over the past 20 years, approximately 2.5% of returns have come from dividends.6 so the current; level of dividend support is nearly double the average - which many investors may not realise.
What does this mean for you?
Cautious optimism - we are cautiously optimistic about emerging market economies relative to their developed peers. Despite the current environment of slowing growth, rising inflation and geopolitical issues globally, we have confidence in both the emerging markets asset class and our strategies. We continue to seek high-quality business with solid balance sheets, competitive advantages and attractive valuations.
At the company level, there are opportunities in high-quality and high-growth companies. Emerging markets are home to some of the most innovative, technology-oriented companies in the world—companies that are building the critical digital architecture of the world around us.
These include world-class hardware and software suppliers as well as the leading advanced semiconductor manufacturers. Some are at the leading edge of the transition to a low carbon future. Many emerging market companies are established global leaders in the production of electric vehicles and electric batteries, and in renewable energy such as in solar manufacturing.
1. Source: ONS, October 2022
2. Sources: CEIC, “Mexico Household Debt: % of GDP,” June 2022. CEIC, “United Kingdom Household Debt: % of GDP,” June 2022.
3. Source: Factset. Price-to-book ratio is a financial ratio used to compare a company's current market value to its book value.
4. Sources: MSCI, Nasdaq. The MSCI EM Index is a free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global emerging markets. The S&P 500 is a market capitalization-weighted index of 500 stocks designed to measure total U.S. equity market performance. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator of future results. See www.franklintempletondatasources.com for additional data provider information.
5. Source: Factset.
6. Source: factset, FTEME.
What are the risks?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.
Franklin Templeton and our Specialist Investment Managers have certain environmental, sustainability and governance (ESG) goals or capabilities; however, not all strategies are managed to “ESG” oriented objectives.
Important Legal Information
This website is intended to be of general interest only and does not constitute legal or tax advice nor is it an offer for shares or invitation to apply for shares of the Templeton Emerging Markets Investment Trust (TEMIT). Nothing in this website should be construed as investment advice. Opinions expressed are the author's at publication date and they are subject to change without prior notice. Subscriptions to TEMIT can only be made on the basis of the latest available audited TEMIT annual report and TEMIT half-yearly report if published thereafter.
The value of shares in TEMIT and income received from it can go down as well as up, and investors may not get back the full amount invested. Past performance is not an indicator or a guarantee of future performance. Currency fluctuations may affect the value of overseas investments. When investing in a fund denominated in a foreign currency, your performance may also be affected by currency fluctuations. An investment in TEMIT entails risks which are described in the TEMIT annual report. In emerging markets, the risks can be greater than in developed markets. Investments in derivative instruments entail specific risks more fully described in the TEMIT annual report.
US Persons are not eligible to invest in TEMIT. Shares of the TEMIT are available for sale and distribution in the UK. Any research and analysis contained in this website has been procured by Franklin Templeton Investments for its own purposes and is provided to you only incidentally. References to particular industries, sectors or companies are for general information and are not necessarily indicative of TEMIT's holding at any one time.
References to indices are made for comparative purposes only and are provided to represent the investment environment existing during the time periods shown. An index is unmanaged and one cannot invest directly in an index. The performance of the index does not include the deduction of expenses and does not represent the performance of any Franklin Templeton fund.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.
There is no guarantee that TEMIT will achieve its objective. Please consult your financial adviser before deciding to invest. You can download a copy of the latest TEMIT annual report and TEMIT half-yearly report, or request one, free of charge, from Franklin Templeton Investment Management Limited, Cannon Place, 78 Cannon Street, London EC4N 6HL. Authorised and regulated by the Financial Conduct Authority. Telephone: 0800 305 306, Email: firstname.lastname@example.org.