Emerging Markets Era of Outperformance Is Ending, Goldman Says
The decade-long outperformance of developing-nation assets has ended, according to the Goldman Sachs Group Inc. economist who predicted the rise of the biggest emerging markets in 2003.
The five trends that spurred outsized gains during the past 10 years -- surging growth in the so-called BRIC nations, higher commodities, improved government finances, slower inflation and lower U.S. bond yields -- are halting and in some cases reversing, Dominic Wilson, the chief markets economist at New York-based Goldman Sachs, wrote in a report dated yesterday.
“While cyclical opportunities will come and go, the era of structural outperformance for EM is probably over,” he wrote.
Emerging-market stocks, bonds and currencies tumbled today amid speculation the U.S. Federal Reserve will reduce monetary stimulus that has spurred $3.9 trillion of capital inflows into developing nations during the past four years. Wilson, who predicted Brazil, Russia, India and China would join the ranks of the world’s largest economies in a 2003 research report while working with economist Jim O’Neill, now says their contribution to global growth is peaking. O’Neill, who retired from Goldman Sachs this year, coined the BRIC moniker in 2001.
The MSCI Emerging Markets Index sank 3.2 percent to an 11-month low of 916.17 at 8:32 a.m. in New York, while currencies in India, the Philippines and South Korea weakened more than 1 percent and South African bond yields surged. Fed Chairman Ben S. Bernanke said yesterday policy makers may start reducing debt purchases and end the program in 2014 should risks to the U.S. economy abate.
Even with the recent losses, the MSCI emerging index has climbed about 214 percent since the end of 2002, compared with an 85 percent gain in the Standard & Poor’s 500 Index. (SPX) JPMorgan Chase & Co.’s gauge of developing-nation currencies has returned 103 percent in the same period.
“Over the next decade, EM assets are unlikely to deliver the kind of risk-reward that investors had become used to in the last one,” Wilson wrote. “And absolute returns will likely be much lower.”
Jan Dehn, the head of research at Ashmore Investment Management, says declines in emerging markets are a buying opportunity because valuations have gotten cheap.
The MSCI gauge trades for 1.4 times net assets, a 28 percent discount versus the MSCI World index of developed-nation shares, according to data compiled by Bloomberg. That compares with an average discount of less than 1 percent during the past five years.
“The right thing to do here, obviously, is to buy,” Dehn said by e-mail.
Valuations in developing-nation debt and currency markets have become more expensive in the past decade, according to Wilson. The extra yield investors demand to own emerging-market government bonds over Treasuries has dropped to about 1.1 percentage point from 4 percentage points, excluding Argentina and Venezuela, he wrote. The average emerging-market currency is now 10 percent overvalued, according to Wilson, who cited a Goldman Sachs model.
The economist said investors may need to focus on country-specific drivers, instead of relying on a repeat of the widespread rally in emerging markets that defined the last decade.
“What we may be seeing is a return to conventional EM investing, where differentiation rather than broad exposure to the asset class becomes a larger part of the investment process,” Wilson said.
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