According to this report while examining the reasons for doing business in EMs, the developed market (DM) corporates indicated that growth and the lower cost of doing business as two major reasons. But while the first reason will definitely hold in the medium/long term the second reason may not hold even in the short term. Risk of doing business is in EMs is certainly going up. Unfortunately risk of doing business at home/developed markets is also going up given the current economic environment and the risk averseness that has come about. One of the main reasons for US companies performing well in 2005-2007 was that emerging markets were doing exceptionally well and the slower/lower demand growth at home was more than offset by the demand growth in emerging markets.
The report also cites China, India and Russia as the major target markets for corporations from the developed world. Given the impact of the economic crises together with increase in the overall geopolitical risk that would be now priced-in, the cost of doing business in India and other EMs in general will not only increase but the return expectation will also be higher. The currency performance would then be a much more major factor for those companies which look at EMs for their future growth. The current situation indicates that for some length of time the EM currencies are going to be under pressure.
Surprisingly the report states that only 41% of the DM companies have a risk strategy for emerging markets and 56% say that no strategy in place! Add to it that only 25% of the North American companies have a risk management strategy that covers EMs!! Further in terms of most important risk ‘Security’ was third from the bottom – this perception is going to alter dramatically now.
While the future is going to thick with large regulatory and compliance risk (as new laws are enacted to control the behavior of banks… to rating agencies) given the above background the cost of managing ‘Security’ related risk – be it related to establishments or individuals - especially for companies with large EM presence is going to be high. The point that, weakening world financial health makes countries vulnerable to geo-political and security risk has been made before in my previous posts. So the so called ‘outlier’ events may not remain there and may become more frequent if we do not get ourselves out of this the economic muddle quickly – to me given the dynamics involved it looks unlikely.
Overall given the increasing cost of doing business, given the current risk aversion and increasing business, financial and security risk in EMs will call for new business models and much higher return expectations putting pressure on stock performance of these companies.
What I have said above is also in the context of some of the articles/opinions I have been reading of late...the bottoming kind of scenarios.
1.
“In terms of valuation, since 1992 emerging market stocks have traded at an average trailing P/E multiple of around 15x. That ratio is now approaching 8x, a record low. For the sake of comparison, the ratio was around 12x during the emerging markets crisis following the Russian default in 1998, and the ratio was around 10x after the collapse of the Internet bubble a couple of years later.”
“In terms of valuation, since 1992 emerging market stocks have traded at an average trailing P/E multiple of around 15x. That ratio is now approaching 8x, a record low. For the sake of comparison, the ratio was around 12x during the emerging markets crisis following the Russian default in 1998, and the ratio was around 10x after the collapse of the Internet bubble a couple of years later.” 2.
“If history is a guide, this re-rating represents an opportunity for long-term investors. Using data since 1992, the table below illustrates the potential for an upswing in the emerging markets when the valuation multiple falls 10 percent below the long-term mean (a trailing multiple of 13.5x or less). Against this background, the current valuation level is even more compelling.”
To me the fact that it has gone below the recent historical lows indicates that the underlying is changing and I would want to wait and watch. Basically it reflects the uncertainty that is prevailing over the result of various measures and packages that are being announced across all markets. The problem with these kind of individual measures being announced in such an interconnected world is that while it may seem right for individual situations (with uncertain results) but holistically how it will manifest (on a global basis) is even more difficult to predict.
“If history is a guide, this re-rating represents an opportunity for long-term investors. Using data since 1992, the table below illustrates the potential for an upswing in the emerging markets when the valuation multiple falls 10 percent below the long-term mean (a trailing multiple of 13.5x or less). Against this background, the current valuation level is even more compelling.”To me the fact that it has gone below the recent historical lows indicates that the underlying is changing and I would want to wait and watch. Basically it reflects the uncertainty that is prevailing over the result of various measures and packages that are being announced across all markets. The problem with these kind of individual measures being announced in such an interconnected world is that while it may seem right for individual situations (with uncertain results) but holistically how it will manifest (on a global basis) is even more difficult to predict.
One should remember while the risk that individual institutions carried may have appeared to be with in the norms of their risk appetite (as measured by VaR, MTM, asset cover etc.) but on a system wide basis, nobody had a clue of its effects. When a minor imbalance happened the whole system fell like a pack of cards and here we are. Systemic effects are difficult to asses.
3.
“In addition, inflationary pressure will be a critical driver. Inflation has been a vulnerability of many emerging markets in the last two years. There's an inverse relationship between inflation (measured by CPI) and stock valuations, as shown in the chart below. Many economists believe that inflationary expectations have peaked, which if true should be positive for valuations.”
“In addition, inflationary pressure will be a critical driver. Inflation has been a vulnerability of many emerging markets in the last two years. There's an inverse relationship between inflation (measured by CPI) and stock valuations, as shown in the chart below. Many economists believe that inflationary expectations have peaked, which if true should be positive for valuations.”This would be a function of USD behaves in future as commodity related inflation has a direct bearing on inflation levels in EMs – specially the commodity consuming countries like India & China. Even if the relationship was correct if you believe that USD is near its peak, then the inflationary pressure is going to re-emerge.
I therefore think it would be premature to use past market behavior as an indicator to invest in EMs or EM dependent companies - from a medium to longer term point of view. Short term bets can be taken to take advantage of dead cat bounces. Time wise I believe we will have enough opportunity as the correction will last for a reasonably long time.
Bottom Line: Reward may not necessarily follow risk. Payoff depends up on the probability being on your side.
I therefore think it would be premature to use past market behavior as an indicator to invest in EMs or EM dependent companies - from a medium to longer term point of view. Short term bets can be taken to take advantage of dead cat bounces. Time wise I believe we will have enough opportunity as the correction will last for a reasonably long time.
Bottom Line: Reward may not necessarily follow risk. Payoff depends up on the probability being on your side.
Disclosure : No stocks discussed – No positions.
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