Addressing Investor Concerns after Heightened Volatility
Investors’ concerns have risen after seeing news of political unrest in Thailand, tensions in the Korean peninsula and sovereign debt issues in parts of Europe. I’d like to share with you some of the questions that our investors have been asking and responses to them from my emerging markets team.
With all the news coming from Europe and Asia, there are renewed talks of a double-dip scenario. Do you think this is likely?
We believe a double-dip scenario is not likely right now since we have seen tremendous efforts on the part of governments globally to avoid another downturn, by keeping money supply high and interest rates relatively low. Now, there is a tradeoff between loose monetary policy and the possibility of inflation, and so in some cases authorities are allowing yields and interest rates to creep up slightly. But generally speaking, the mode of operation in Europe and the U.S. is to ensure high liquidity.
In addition, a number of leading indicators point to continuing consumer growth. We believe the Purchasing Managers Index (PMI) is a very good leading indicator of consumer sentiment. The PMI in both China and the U.S. is back up to 2007 levels, which implies a recovery in consumer sentiment. Data from the U.S. also continues to indicate improving conditions.
What could be possible conduits for contagion from what is currently happening in Europe to spread to Asia or other emerging markets?
The most obvious one would be trade. If there’s a big downturn in trade, in other words, if Europe were to set up protectionist barriers and dramatically reduce imports, there could be a knock-on effect in Asia and other emerging markets. For example, about 12% of Thailand’s exports go to Europe, which is its second-largest market after the ASEAN region. Moreover, Europeans constitute the biggest contingent of tourists for Thailand, where tourism is an important contributor to GDP. Similar trends are true for most other countries in South East Asia. What is now happening in Europe may have an impact on these countries both in terms of trade as well as tourism.
But it is important to note that the percentage of exports going to Europe and the U.S. from emerging markets has declined. Now China (rather than the U.S. or Europe) is the largest trading partner for most Asian countries. For example, around 20% of South Korean exports were going to the U.S. in 2003, but that figure has now come down to around 11-12%. In contrast, the percentage of South Korean exports to the rest of Asia has now surpassed 50%, primarily because of demand from China and India. Essentially, many East Asian countries are benefiting from strong economic growth in China and India.
Where do you see emerging markets going from here on?
When trying to predict the direction of markets, one of the things we look at is supply and demand. Looking at the supply environment, generally speaking, as the market moves up, the number of IPOs increases. Over the years, emerging markets’ share of global IPO activity has dramatically increased. In 2000, IPOs in emerging markets amounted to about 20% of the total IPO market, while last year, emerging market IPOs represented approximately 73% of global IPO activity. We expect even more activity this year. It is important to consider IPO activity since it could have a downward impact on markets—the greater the supply of shares coming to the market, the less the likelihood of seeing an active upward trend, because money is likely to be directed toward the new issues and away from existing shares in the market.
Regarding demand, generally speaking, investors around the world are underweight emerging markets. On average, investors (particularly institutional investors, but also retail investors) have a weighting of approximately 3-8% toward emerging markets in their portfolios, while emerging markets now represent about 30% of the global market capitalization. This leads us to believe that the potential demand for emerging markets is likely to be significant.
Underlining this belief is the knowledge that emerging markets continue to be fundamentally strong, with high growth levels, a lower debt-to-GDP ratio compared to developed markets, higher foreign reserves and a change in the perception of risk, with credit default swaps (CDS) of many emerging market countries now trading at lower spreads than that of some European countries.
 Source: Factset.
 Source: Bank of Thailand, Credit Suisse.
 Source: Dealogic.
 Source: MSCI, Pensions & Investments, as of 6 Jan 2010.