Emerging market equities are lagging developed markets this year. However, the underperformance creates an opportunity in our view, and does little to change our long-term outlook for emerging markets, where we believe some of the strongest growth opportunities lie.
We believe some of the current issues holding emerging market equities back from their developed market peers are actually long-term positives for emerging markets.
In our view, the recent under-performance of emerging markets can be explained by a few key factors: Investors are not valuing long-term growth due to a heightened focus on dividends; easy monetary policy in developed countries has boosted those equity markets; government policies in some of the largest emerging market countries are discouraging investors; and investors fear that weaker commodity prices will negatively impact emerging market economies.
While these factors have weighed on emerging market stocks in recent months, we think many of the actions taken by emerging market businesses and policymakers around these issues are supportive of those markets over the long term. Consider decisions by emerging market companies on dividend payouts. Although emerging market equities typically have higher dividend yields than developed market equities, companies in emerging markets have not been increasing dividends the way companies in developed markets have. Instead of hiking dividends, many emerging market companies have chosen to reinvest cash flow into their businesses to take advantage of long-term growth opportunities in their fast-growing economies.
In China, for instance, banks are holding more capital so they have the reserves necessary to make loans to support loan growth to a growing middle class. Other companies are investing in their business to cater to the needs of tens of millions of Chinese moving to urban centers every year. Technology companies are building new factories to meet the demands of billions of emerging market consumers who are getting their first phone and quickly embracing other new technologies. Companies in India are building ports to help import the commodities needed to power the country for the next century.
While reinvesting in the business to take advantage of these opportunities diverts cash flow from dividends, the move should raise earnings growth rates for most of these companies. In normal markets, that is a desirable trade-off. In the yield-seeking market of the past few years, however, the market has focused on companies growing their dividends, hurting emerging market equities.
The loose monetary policy adopted primarily by developed market central banks is another reason those equity markets have outperformed emerging markets. With interest rates low, investors in developed markets are encouraged to turn to equity markets to seek greater returns. Central banks in emerging markets, however, have kept their interest rates considerably higher. Again, we think this is a prudent move. Lower interest rates in emerging market countries would risk massive inflation, destabilizing the economy and weakening the consumer. We are happy to see emerging market central banks working to keep these risks in check.
Government policies are another factor holding back the performance of emerging markets. In many cases, these regulatory or policy decisions are the right long-term decisions for these markets, but have created volatility in the earnings outlook of companies in select industries. Financial reform in China for example, is creating a sounder banking system, but is weighing on bank profits and growth in the short term.
New leadership in China is taking steps to fight corruption by government officials. These steps have reduced the amount of “gifting” to government officials, which has weighed on demand for luxury goods in the short term, but less corruption will create a more favorable, competitive environment over time.
In other countries, political missteps have admittedly harmed local economies. In India, political corruption scandals have led to increased media scrutiny. A more fearful and bureaucratic government has been slow to implement structural changes needed to move the economy forward.
In Brazil, the government regulated banking spreads between loan and deposit rates, reducing profits for banks in the country. The Brazilian government also tried to keep petroleum prices artificially low, which left local oil companies without enough capital to invest in growth opportunities. Some of these government missteps are legitimate concerns, but we believe those problems will subside over time.
Concerns about weak commodity prices negatively impacting the more commodity-driven emerging economies have also weighed on emerging market stocks. These fears are based on the premise that a hard landing for the Chinese economy will put a lot of pressure on commodity prices. We think these fears are overblown. While China might not experience the same growth it did over the last decade, we believe the Chinese economy will avoid a hard landing and exhibit healthy economic growth once businesses get more comfortable with the economic policies of the country’s new political leadership.
While government policies, higher interest rates and the market undervaluing future earnings growth opportunities have held back emerging market equities in the past few months, we think the longer term growth prospects for these markets are hard to deny. The demographics of emerging market countries are the envy of the developed world. A rising middle class is starting at low income levels, low levels of technology usage and lower health care utilization. Many of these consumers are getting easier access to credit for the first time, and home and auto ownership are still new ambitions. A number of developing industries are ramping up exports to compete globally. We believe companies exposed to these trends represent some of the best multidecade growth opportunities in the world.
Please consider the charges, risks, expenses and investment objectives carefully before investing. For a prospectus containing this and other information, please call Janus at 877.335.2687 or download the file from janus.com/info. Read it carefully before you invest or send money.
Investing involves market risk. Investment return and value will fluctuate, and it is possible to lose money by investing.
The value of equity securities fluctuates in response to issuer, political, market, and economic developments. In the short term, equity prices can fluctuate dramatically in response to these developments which can also affect a single issuer, issuers within an industry or economic sector or geographic region, or the market as a whole.
Emerging market investments have historically been subject to significant gains and/or losses. As such, returns may be subject to volatility.
The views expressed are those of Janus research analysts. They do not necessarily reflect the views of Janus portfolio managers or other persons in Janus’ organization. These views are subject to change at any time based on market and other conditions, and Janus disclaims any responsibility to update such views. No forecasts can be guaranteed. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any Janus fund.
In preparing this document, Janus has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources.
Statements in this piece that reflect projections or expectations of future financial or economic performance of the markets in general are forward-looking statements. Actual results or events may differ materially from those projected, estimated, assumed or anticipated in any such forward-looking statements. Important factors that could result in such differences, in addition to the other factors noted with such forward-looking statements, include general economic conditions such as inflation, recession and interest rates.
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