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Developing economies - Boom or Bust?

Investing in developing economies will always have many feeling uneasy. Smaller economies are more likely to suffer knock-on shocks from decisions and changes in larger economies and while larger ones may be able to shrug off small wobbles, developing economies often do not have the immune system to allow them to avoid catching a cold when a neighbour sneezes. However, with the risks comes the promise of bigger rewards.

Invesco Perpetual Emerging Markets Update [Report] sees the start of 2007 being a weak time for emerging economies, although it finds "US growth prospects and sliding commodity prices abated somewhat during the latter stages of January".

The update comments that January saw early losses in Latin America "short lived as a rebound in the price of oil along with firming commodity prices elsewhere triggered a wave of buying". Globally the best performing economies were Malaysia, Poland, Turkey and Chile.

The AXA Framlington Monthly Market View [Report] in September 06, sees what unexpected dangers exist in emerging and developing economies. A coup in Thailand and nuclear testing in North Korea both hit investors confidence within the countries themselves and beyond. However, the report states the countries of Asia are in a strong position than in decades gone by.

It states: "Asian equity markets have continued to do well and outperformed Japan. Much of the performance has come from domestically focused sectors, such as financials. We would expect the Asian cycle to roll over if the US does slow down but the region is in a much stronger position to offset lower exports than was the case in the mid-1990s."

Schroders Emerging Market Monthly View [Report] sees emerging markets following the similar pattern growth to larger economies. The report concludes: "Stocks benefited from unchanged US interest rates and the growing view that the slowdown in the US economy will be a gradual one and that a recession will be avoided, boding well for the export-sensitive economies of the emerging markets region."

At the start of 2007, the JPMorgan Emerging Markets Review of 2006 and Outlook for 2007 [Report] also predicts that global economic growth, in both developed and developing countries, underpinned likelihood of the US achieving a soft landing, Chinese growth continuing at a "robust pace", and ongoing recovery in the Japanese and Eurozone economies, boding well for corporate earnings.

It states: "While profits growth will remain positive it is likely to be lower than in 2006, as the business cycle matures and top line revenue growth slows. Fortunately equities have the support of attractive valuations, both relative to their history and to other asset classes, and we anticipate a further year of out-performance.

"Government bond markets offer limited value, with real yields below two per cent for the four major markets. Yields are at levels that appear inconsistent with the soft landing thesis for the US economy, and the fall in bond prices that followed the stronger than expected November jobs data suggest there is little room in current bond prices for 'good' economic data."

Kim Catechis, fund manager of SWIP Emerging Market Fund, [Report] reports that the turn of the year saw emerging market equities markets enjoying robust growth.

He writes: "In Asia, China was again a major factor behind the gains. Positive results from Chinese companies and evidence of strong consumer spending helped boost the market. Investors are proving increasingly keen on the region and recently channelled more than $1 billion into Chinese funds in a four-week period."

Latin American stock markets are described as being among the world's best performers in December, with Mr Catechis explaining that "encouraging economic data and strong corporate results were a boost to the Brazilian index, while Mexican shares rose after Felipe Calderon was sworn in as president".

However, the worst performing market was Thailand. "This was mainly due to the Bank of Thailand's decision to impose capital constraints on investors," he explained. "The market collapsed following the news, although many of the restrictions were subsequently lifted."

At Standard Life's Global Emerging Market Equities [Report] Ronnie Petrie sees commodity markets in Latin America wary of a slowing US economy, while Pacific Basin and Asian Markets become more positive.

He writes: "The commodity heavy markets of Latin America are nervous about the prospect of further flights of foreign capital, especially as the US economy shows signs of slowing, while Pacific Basin markets look less threatened.

"More diversified in composition, Asian markets still offer attractive opportunities. In particular, many property and banking stocks are undervalued against a backdrop of improving domestic drivers."

Other investment areas highlighted included African media, Philippine office property and the Thai beverages, although across these sectors there are companies to pick and those to avoid.

Allianz Global Investors BRIC Stars Fund [Report] specialises in the equity markets of Brazil, Russia, India and China, but up to a third of the fund is invested in developing countries. Investments cover a number of sectors - including energy, financials, materials and industrials - at roughly equal levels.

Fund manager Michael Konstantinov highlights China and Brazil as good performers, with stronger performance across the board aided by strong earnings growth, despite worries about US interest rates.

He writes: "Privatisations in China raised investor appetite for Chinese stocks from domestic as well as foreign investors and helped the market to appreciate.

"The Brazilian market, was driven by continued expectations of further interest rate reductions as well as the re-election of president Lula which stopped the ongoing political uncertainty."

In Russia the equity market in Russia continued to do well generally, supported by its strong economy

Mr Konstantinov adds: "We maintain our view that the economic growth in the US would not experience a sharp slow-down. As well as this, we believe the Chinese and Indian economies will remain at a high rate of growth. This should continue to provide support for global equity markets and BRIC markets in particular."

However, the fund warns - which should be taken as a word of caution to all those looking at emerging and developing economies - that it can be "highly volatile and carry a higher risk both in terms of market and currency volatility, which may result in dramatic fluctuations from time to time".

The key with investing in developing and emerging markets is to know the market. While one sector may be facing boom, within the same nation another maybe in bust. International economic forces are also more likely to hit harder along with more unpredictable local events that can rock the boat, such as bird flu outbreak, coups or nuclear testing. However, prospects for greater growth than in established markets are also present in developing economies.