Normalisation of US interest rates is likely to lead to a correction in emerging markets in 2004, says Pictet Asset Management. Economic reforms and improved fiscal positions mean that the scale of any interest rate rise will be less severe than that felt in 1994. However certain markets, Indonesia, Brazil and Turkey, still look particularly vulnerable.
In China, international investors have poured funds into the market, participating in its explosive growth. In the first 9 months of 2003, GDP growth reached 11 per cent, now there is a risk that physical capacity constraints will fuel inflationary pressures and that aggressive bank lending will need to be restrained. With the MSCI China Index having risen by 88 per cent (MSCI, total return) in US$ terms in 2003, valuations of many stocks are high and the risks are clear.
Pictet has adopted a more cautious approach towards India, Brazil, Indonesia and Turkey by recently taking profits. “However on any set back in valuations we would look to fully re-establish exposure within these markets which remain key overweight positions in our portfolios,” says John-Paul Smith, Head of Emerging Markets at Pictet Asset Management.
“The adoption of a lower risk profile within emerging market portfolios also suggests that the out-performance by small to mid-cap value stocks, which have generally been most sought after by investors, may well give way to a period of better relative performance by larger capitalised growth stocks. The greater liquidity of larger companies is likely to be attractive to investors during any market set-back,” adds John-Paul Smith.
In the medium to longer-term, Pictet remains confident that emerging markets will provide attractive relative returns to investors. “The combination of positive demographics, economic and political reform, growing foreign direct investment and strong domestic liquidity flows, creates a vibrant set of opportunities for investors”, comments John-Paul Smith. “With market valuations remaining at a discount compared to those in many developed markets, we believe that institutional investors will continue to be attracted to the better risk/reward prospects offered.”