Since the beginning of November, the MSCI World Index in Sterling has posted healthy returns, whereas markets such as Brazil have fallen by 2.6 per cent and India has slumped by 14.5 per cent.
Performance of indices since Nov-10
Source: Financial Express Analytics
A consolidation phase was required as these markets became heavily overbought at the end of last year and we are now looking for opportunities to rebuild exposure.
We have to be realistic as not all emerging markets are created equal so it is about selectivity. There are arguments suggesting that emerging market growth will catch up with that of developed markets; the reality is that global economic growth is likely to be slow whilst the West works out decades of excess.
A rebalancing of economies from a heavy dependence from the major importers towards domestic demand in the surplus countries would be advantageous but an unlikely scenario.
In practice we are likely to see slower export growth from both the developed and emerging markets than in the past decade.
Whilst we are seeing little movement towards increasing incomes and therefore consumption levels in emerging markets, countries such as China, Russia, Brazil and India have high levels of foreign reserves, they are bringing in wealth and in relation to GDP they have lower levels of debt than several years ago.
As a result of our quest for selective opportunities we have acquired positions in India Infrastructure and India Capital Growth. Whilst geographically they have much in common, the rationale behind each trade could not be more different.
The sorry history of the construction of India Infrastructure’s toll road highlights how difficult it is to see such projects through on the sub-continent. It has taken 15 years to complete the road after being held up at every turn by bureaucracy and corruption.
It is now close to opening and the discount rate used to calculate its net asset value will fall given that construction risk is no longer a factor. The shares already trade well below historic valuation and we enjoyed a healthy re-rating shortly after purchase.
In the case of India Capital Growth, we are seeking to exploit the fact that it is usually the case with investment trusts that when there is a change of manager, they continue to trade on the track record of the vehicle rather than that of the new appointee.
This trust, during its relatively short life, has already suffered two under-performing managers and has lost half of its initial launch proceeds. The possibility that the new man holding the reins, David Cornell, will succeed where others have failed is not factored into the current market share price.
Ultimately I remain of the view that the global financial system will muddle through. The leverage within the bank sector should steadily decline over time, bringing down the risk of a further crisis.
In such an environment, equity valuations should be higher than where they are today. There are two caveats: leverage is still high and an accident is clearly still possible. There is no guarantee that a meltdown could be avoided as it was in 2008.
The risks to the downside remain far greater than they have been in most previous investment cycles. Furthermore I believe that the market is failing to factor into earnings estimates that the tax-take in the West will run steadily higher, leaving plenty of room for disappointment.
My portfolios are therefore constructed on the basis there will not necessarily be any help forthcoming from a general rise in market levels so stock selection becomes ever more important.
Nick Greenwood manages Capita Financial Managers. The views expressed here are his own.