Chetan Sehgal, Lead Portfolio Manager at Templeton Emerging Markets Investment Trust (TEMIT), shares three reasons to remain bullish on emerging markets long term, including emerging market debt levels remaining low, attractive valuations, and improving cashflows.
Emerging markets have seen progress on back of an uptick in vaccination rollouts, but the recent Chinese regulatory crackdown and further virus outbreaks have caused equities to generally underperform year to date relative to developed markets. With a focus on emerging markets outside of Asia, Lead Portfolio Manager of Templeton Emerging Markets Investment Trust (TEMIT), Chetan Sehgal, nonetheless remains bullish on the long-term potential of emerging markets and outlines three main reasons: debt, valuations and cashflows.
Emerging Market Debt Remains Relatively Low
As we examine the emerging markets landscape today, the rise of leverage within economies is a key trend we have witnessed. Leverage can be a double-edged sword, as it can be positive, but also represents a source of risk. Over the past decade, the level of debt has gone up not just in emerging markets, but across the world. COVID-19 has certainly led to a dramatic increase in government debt in some countries, but in general, debt to gross domestic product (GDP) is currently much lower in emerging economies than in developed countries—which is one reason for our bullish view.
Aside from an increase in China, corporate debt as well as household (consumer) debt levels in emerging markets are still much lower than in the developed world, too. As such, we feel that emerging markets have much more headroom available to further increase debt levels without a significantly detrimental impact.
Turning to the structural opportunity this presents, the credit ratios in Latin America and emerging Europe are much lower as a percentage of GDP compared with both the developed world and emerging Asia. This is the reason Latin America and emerging Europe have looked appealing to many investors despite some headwinds. Mexico for example, boasts a debt-to-GDP ratio of less than 50% and while Brazil’s debt-to-GDP is around 100%, it is still much lower than many developed countries. We see a similar story in Eastern Europe, where debt levels are lower in Turkey, Hungary and Poland than countries like Japan, Australia, France, for example, where debt-to-GDP ratios are above 150%.
Attractive Valuations—particularly in Latin America and Eastern Europe
Emerging market equities also hold attractive valuations—another reason for our bullish view. They trade at a discount to the developed world despite strong growth potential and headroom for credit consumption. The forward price-to-earnings (P/E) ratio for emerging markets, as measured by the MSCI Emerging Markets Index, stands at around 13, whereas developed stocks, as represented by the MSCI World Index, have a forward P/E ratio of around 19.
Valuations in Eastern Europe and Latin America are even lower—and not just on an absolute basis, but even relative to their own history. Latin America is rich in natural resources and looks to benefit from the commodity boom taking place amid the recovery from the pandemic. The prices of most of commodities have risen, which represents a natural tailwind for the economies in those regions, with improving terms of trade being one benefit. Brazil is one of the world’s leaders in iron ore production, for example. And Brazil—along with Argentina and Chile—also supply the world with lithium, one of the most important metals in electric vehicle production. Chile and Peru are global leaders in the production of copper, another vital commodity in today’s world that has seen increased demand.
Similarly, countries in Eastern Europe—primarily Russia—are key commodity producers, including nickel, aluminium and of course, Russia is a leading oil-producing nation. Much of the world depends on the commodities produced in Latin America and Eastern Europe, which should bode well for these economies and the companies within related industries.