Emerging markets in a sweet spot
AS I have often said, investing in emerging markets requires patience, long-term perspective, and selective stock-picking. I think many investors focus too much on the short term.
As long-term investors, we view short-term bouts of volatility as an opportune time to find potential bargains for our portfolios, and we certainly experienced that in the first half of the year.
Sentiment in emerging markets seemed to be at a particularly low point at the very start of the year, coming off a weak 2013. As the US Federal Reserve (Fed) started tapering its quantitative easing programme, fears seem to have surfaced that liquidity would dry up, and concerns about potentially slower growth in China this year gave some investors pause.
Headlines of conflict and violence in countries including Ukraine, Turkey, Thailand and Nigeria also affected overall investor sentiment in the first half of the year, along with doubts about the readiness of Russia to host the Winter Olympics and Brazil to host the Fifa World Cup.
On the brighter side, India's market saw a post-election resurgence of hope, China's economy did not experience a hard landing and the upgrade of Qatar and United Arab Emirates to emerging-markets status from frontier appeared to fuel investor interest.
We believe emerging markets overall are now in what could be classified as a "recovery phase" after 2013's underperformance, barring no further unexpected shocks.
We believe it's important as an investor in emerging markets to look at the big picture. During the last 10 years, there have been only three years when emerging markets underperformed developed markets, 2013 being one of them.
In the first half of this year, emerging markets have generally outperformed developed markets, and I would say that we're in a sweet spot in terms of emerging markets' recovery. And we think a number of frontier markets, the even lesser-developed subset of emerging markets, look particularly attractive right now.
We believe some of the fear surrounding emerging markets last year and early this year now appears overblown. From a liquidity perspective, the Fed is not the world's only liquidity provider: Japan has implemented its own quantitative easing programme, China's monetary base has increased, and the European Central Bank recently announced a new swathe of stimulus measures.
It is also important to note that, to date, the Fed has not sharply tightened policy to slow an overheating economy. On the contrary, the US economy appears to be coming off life support as the extraordinary policy measures of recent years are being gradually unwound.
According to our research, many US investors were (and still are) underweight emerging markets but we have recently seen some increased interest. We suspect that the excitement about the US market as it recovered from the 2007-2008 financial crisis caused people to put money there and keep it there. Now we have seen interest in spreading some of those assets to other markets.
The same sort of investor dynamic seems to be taking place in Europe. After a recent seven-country tour around Europe, I was happy to find increased investor interest in emerging markets. People seem to be starting to diversify their assets a bit more.
Indonesia's experience illustrates this increased global investor interest. After a sharp decline in both equities and the rupiah last year, foreign exchange reserves have risen back above US$100 billion (S$125 billion), the rupiah has appreciated and many of the stocks most heavily sold off last year have seen positive returns thus far this year.
We believe such positive performance of many emerging markets could continue as we move into the second half of this year.
However, short-term volatility is likely something we will continue to deal with for the rest of the year and beyond. In some cases, unfortunately, the reaction of some governments will be to enact more repression.
There will be bad news in places, and there will be some companies that fail. We have to be prepared for that as investors - and be prepared to act when opportunity knocks.
The writer is executive chairman, Templeton Emerging Markets Group, at Franklin Templeton Investments.