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Regional Outlook – Emerging Markets Philippe Langham Senior Portfolio Manager RBC Asset Management UK Limited Risk aversion returned to markets this quarter with a renewed focus on the sovereign-debt crisis in Europe and its impact on fragile global economic growth. This has led to a sharp selloff in emerging-market stocks, as well as in other risk assets. In this environment, the high correlation among global stock markets has been evident. The current public-debt stresses in the developed world are a reminder of why it makes sense in the long run to maintain significant exposure to the much healthier economic growth found in emerging markets. Growth in the developed world will continue to be constrained by high government debt and private-sector deleveraging. While emerging economies will not be immune to weaker global growth driven by the deleveraging, their rates of growth are likely to continue to be significantly higher than those of their developed-world counterparts because they do not face the same debt overhang. Inflation in developing markets has begun to fall, as food prices have come down and global growth has slowed. Given the improving inflation data, most emerging-market central banks have begun monetary-easing cycles. This is a clear positive for emergingmarket assets, which suffered for much of last year on concerns over inflation and the associated restrictive monetary policies. Looking ahead, there is a strong case to be made that food prices will continue to decline over the next year given a high level of Emerging Market Datastream Index Equilibrium Normalized Earnings and Valuations 513 394 303 Jun. '12 Range: 205 - 364 (Mid: 285) Jun. '13 Range: 219 - 389 (Mid: 304) Current (01-June-12): 231 233 179 137 106 81 62 48 1995 2000 2005 2010 2015 Source: Datastream, RBC GAM long speculative positions and strong global growth in arable acreage. The one market where there has been some investor disappointment with monetary easing is China. This reflects the leadership’s view that the massive post-Lehman surge in credit was a mistake. It also reflects their view that growth in China can be maintained without the need for aggressive stimulus. Since the EU accounts for a large portion of China’s exports, an even larger slowdown in demand would likely prompt Chinese officials to become more aggressive in stimulating the economy. The valuation case for emerging markets has become more attractive in the past 12 months. Based on consensus 2012 earnings, the forward P/E ratio is under 10 and well below its long-run average. On a price-to-bookvalue basis, emerging-market equities also trade at a significant discount to history and at a level that has historically portended strong 12-month performance. In addition, widening spreads between emerging-market earnings yields and bond yields since 2010 are incongruent with current market conditions, so we expect these yields to converge over time via an uptick in equity prices. The valuation discount to developed markets has also widened following a degree of underperformance over the past year, and now stands at 15%. In terms of positioning, our long-term top-down bias for domestic sectors and quality, and away from cyclical areas and commodities, makes even more sense in the current environment. Equity markets are likely to follow credit markets in distinguishing between good and bad credit. In this environment, companies with strong balance sheets, robust free-cash-flow generation and high returns on capital are likely to outperform. Furthermore, as global growth slows, companies that are able to deliver good growth will enable their stocks to command SAMPLE 62 I The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012
Regional outlook – emerging markets • Philippe Langham premiums. We expect global growth to remain sluggish for several years and identify three long-term themes that are key drivers behind our top-down positioning. Our biggest long-term theme continues to be the growth of domestic consumption in emerging markets. This is confirmed by a number of factors, including double-digit wage growth across many emerging markets over the past decade. Despite this rise in personal incomes, current emergingmarket wages remain considerably below those in developed markets. Interestingly, when we examine income by age in countries such as China and Brazil, it appears that younger workers tend to earn much more than older workers, which reinforces our faith in domestic consumption as a long-term theme. In addition to wage growth, the powerful combination of a high savings rate, relatively low levels of bank credit and a fast-growing middle class make the emerging-market consumer an investment theme that we believe will remain compelling for years to come. Natural gas is a medium-term theme that we believe will play out across a number of emerging-market countries that export energy. The pros of this energy source are its abundance, and the fact that it is cheaper and cleaner than many alternatives. The underpenetration in countries such as China, where only 4% of energy usage is supplied by natural gas, compares with as much as 50% in many developed markets and illustrates the growth potential. Pricing in many emergingmarket countries is regulated at a much higher level than in North America, and with demand growth estimated at 10% to 15%, prices in many emerging markets are likely to increase. The third theme is dividends. The current dividend yield in both emerging and developed markets is just above 3%, and over the last five years dividends have comprised almost twothirds of emerging-market equities’ total returns. Given the low level of bond yields today, and the hunger of many investors for income, we believe that this theme will grow to be as important for emerging-market investors as it already is for those in the developed world. Over the past 10 years, higher-yielding stocks in developing markets have significantly outperformed lower-yielding stocks and the MSCI Emerging Markets Index. The portfolio holds a number of higheryielding issues, partly as a result of the type of company that we focus on – businesses with solid balance sheets, capital discipline and strong cash flows. Looking ahead, correlations between all equity markets are likely to stay high in the short term, and emerging markets face further downside risks as long as the European crisis does not come to a definitive resolution. However, we believe it is only a matter of time before markets refocus on the healthy fundamentals in developing markets, where governments, companies and consumers are not constrained by excess leverage. The post-Lehman low proved to be a fantastic time to buy emerging market equities, and a resolution of the Eurozone crisis is likely to provide a similar opportunity. SAMPLE The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 63
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The Global Investment Outlook RBC I
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Contents Executive Summary 2 The Gl
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Executive summary • Sarah Riopell
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Recommended Asset Mix Asset mix - t
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Recommended Asset Mix Balanced Asse
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Capital markets performance • Mil
Page 13 and 14: Global Investment Outlook Eric Lasc
Page 15 and 16: Global Investment Outlook • Eric
Page 37 and 38: Global Fixed income markets • Soo
Page 45 and 46: Currency Markets Dagmara Fijalkowsk
Page 47 and 48: Currency markets • Dagmara Fijalk
Page 57 and 58: Regional outlook - U.S. • Ray Maw
Page 59 and 60: Regional outlook - CANADA • Stuar
Page 61 and 62: Regional outlook - Europe • Domin
Page 63: Regional outlook - Asia • Yoji Ta
Page 67 and 68: Eric Lascelles Chief Economist RBC
Page 69 and 70: This report has been provided by RB
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