Capital Ideas

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Emerging Markets
Emerging markets rally riding on earnings growth
Shaw Wagener
Equity Portfolio Manager

Emerging markets are benefiting from the global economic recovery, but does the current rally have staying power? Portfolio manager Shaw Wagener weighs in, and offers perspective on how the asset class has evolved.

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Matt Andrejczak: Let’s talk about what’s going on in the emerging markets. There’s a lot of talk about a global synchronized recovery in the world. How do you think that would benefit the emerging markets?

Shaw Wagener: Well there’s no doubt a good economy globally is a good deal for emerging markets. That’s been true in the past, and I would expect it to be true in the future. When the economies of the world are doing well, it means that trade is doing well, so there’s a lot of movement of goods and services. It means there’s a lot of opportunity for those countries that are below the median in terms of economic power and quality can move up to the median and above. So it creates all sorts of opportunities. A global synchronized economic growth environment is about the best possible environment for emerging markets, and it’s similar to what we experienced, really, from 2003 to 2007.

Matt Andrejczak: Judging by the inflows into emerging market funds this year, they seem to be gaining favor again with investors after several rocky years. Where do you think we are in this cycle right now?

Shaw Wagener: I have been lucky enough to be investing in emerging markets since the mid- to late-‘80s, and I have a view going back over that period of time that emerging markets is kind of a peculiar capital market relative to other stock market groups or indices. Over time, emerging market stocks don’t get rerated very much. That is, the multiple doesn’t increase dramatically. You see large multiple increases in the developed markets. The classic example would be the United States at the end of the ‘90s and into early 2000s, where people paid a lot more for the earnings power of U.S. corporations and you got these high P/E multiples.

In emerging markets, that doesn’t happen very often. And what that means, then, is that the returns in emerging markets tend to be driven by earnings growth. So if the multiple stays relatively stable, the only way emerging market stocks go up is if the earnings grow — and then, of course, the dividends increase along with earnings growth. We’re in a stage now in emerging markets where we’ve gone through three or four tough years of economic adjustment and change, and even the composition of emerging market stocks has changed dramatically. Now we’re coming out of that period, and we’re starting to see some very robust and strong earnings growth in emerging market equities, which as I say, over time, is what drives prices in emerging markets stocks.

Matt Andrejczak: You talked about the composition of the emerging markets. Can you talk about that evolution in emerging markets, and where do you see it headed in the future?

Shaw Wagener: People talk about emerging markets as being homogeneous, but actually emerging markets are very heterogeneous on many fronts. Clearly, in terms of governments, you have very different governments within all the countries we invest in. But importantly, you have a very different composition of the emerging markets universe today in sectors and industry terms versus what it was, say 20 years ago. When we first started investing in emerging markets in the late ‘80s, early ‘90s, it was heavily driven by government-owned enterprises: telecommunications companies, utilities, things like that. That dominated the investment universe for us in those early days. There weren’t that many private companies.

What’s happened in the last 20 years is you’ve had a big increase in intellectual-based industries. So technology — which you mentioned — you have some very strong leading technology companies, globally based, in emerging markets that provide internet-related services, but importantly, also information technology hardware. The same thing is true in financial services. You have some wonderful financial service companies in emerging markets that offer great total return over time, that are basically intellectual property–based businesses, which have popped up and become quite strong in the last decade or so.

Against that you’ve had a drop, then, in the more commodity-based businesses: energy, materials, mining. And those are the things that most people think of in a homogeneous way when they think of emerging markets. They always think, “Well, that’s where all the commodities come from.” But in fact, today those commodity-based sectors are less than 20% of the overall universe in emerging markets.



Shaw Wagener is chairman of Capital Group International, Inc. and an equity portfolio manager. He has 37 years of investment experience. He earned a bachelor's degree from Claremont McKenna College and is a CFA charterholder.

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