Are Emerging Markets Finally Poised for a Rebound?

NEW YORK (The Street) --- Emerging markets are poised for a better year in 2014 after lackluster 12 months, but fund managers warn against playing one market too heavily. In other words, diversify among a variety of markets and regions.

The MSCI Emerging Markets Index posted a mere 5% gain last year whereas the S&P 500  post a gargantuan 26% advance and Japan's Nikkei posted a rather astounding 52% gain. Fund managers point to increasing diversion between emerging market economies: several carry high debt levels while others are have companies with lean cost structures expected to benefit from stronger earnings growth.

Among the most vulnerable to volatility are emerging markets dependent on developed economies to fund their current account deficits. These include the so-called Fragile Five: Indonesia, India, Turkey and Brazil, South Africa. On the flipside, a cut to bond purchases by the Federal Reserve in December may reduce near-term uncertainty for these markets as the Fed engineers its 'taper timing.' 

Goldman Sachs analysts suggest greater certainty around Fed bond buying intentions will see investors focus on emerging market fundamentals - but note, bouts of pressure from periodic US rate rises.

Henderson Global Investors head of global equities Matthew Beesley said that despite Fed tapering, ongoing stimulus from economies such as Japan would giving a further boost to emerging market equities.

But he warns of a broader shift. "We've been through 10 years where growth was driven by emerging markets expansion and lower cost of production - now developed market growth is accelerating from a low base and emerging market growth is decelerating from a high base," the London-based Beesely said in a phone interview.

Beesely says profit margins are at record level in the US but well short of their peak in Europe and Japan. "European companies have been cost-cutting for 4 to 5 years, and Japanese companies have been doing it for 15 years, so any top-live (revenue growth) surprises will be significant for the bottom line," he said. On the flipside, Beesley is cautious on China, pointing to its credit expansion and large private sector debt to GDP ratio. Overall, he prefers developed to emerging markets. 

Societe Generale strategists are more optimistic. They say emerging markets growth should gather pace early this year, helped by the US driving the global recovery. "Ukraine, Venezuela and South Africa appear to be the most vulnerable while China, the Philippines, and Peru are the least," the bank's head of emerging markets strategy Benoit Anne said in a research note. "China should continue to play an important role - our economic team see the Chinese economy decelerating a bit, but the country should still grow at a sustained pace (7.4% versus 7.6% for 2013)."

Anne says growth in Asia should outpace other regions. In Latin America, he expects Peru, Chile and Colombia will continue to show strong economic performance - partly from the high volumes of exports to Asia - while growth in Mexico and Brazil will remain more modest. He points to Turkey as a stands out for growth performance in the Europe, Middle East and Africa region. "Emerging market fundamentals remain attractive, especially versus developed markets," he said.

The French bank notes that based on IMF forecasts, emerging markets GDP growth should be around 5% in the next two years, well above the 2.1% average expected for developed countries.

-- By Jane Searle in New York 

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