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Some emerging markets are more promising than others

Buy low, sell high. This is the only secret investors need to know. But the big problem right now is trying to get a handle on which assets are actually going cheap.

Major western indices have been hitting new records, with even the FTSE 100 coming to the party, despite its heavy weighting to the slumping energy and mining sectors. But worries about “secular stagnation” have clouded the outlook – and investors have been corralled by fear into similar asset classes. Finding investments that are cheap and under-owned is becoming increasingly difficult.

Secular stagnation is a condition of negligible or no economic growth. It is caused by low technological innovation and negative population dynamics, which reduces investment. This leads to a fall in future returns and growth.

Some, such as former US Treasury Secretary Larry Summers, think this is the situation now faced in the West. If we are in for a period of stagnation, there is a question mark about Western valuations. By no means are valuations looking stretched, but they are not cheap either.

The obvious way to find under-owned opportunities is usually to look at emerging markets. They account for more than half of the global economy. However, their daunting fundamentals have led investors to withdraw money at an astonishing rate.

At the moment, emerging markets are suffering their largest capital outflows since the financial crisis, accelerated by the stronger US dollar, as the first rate rise by the Federal Reserve in almost a decade looms large. However, rises are likely to be limited and gradual.

The ability of many emerging markets to repay their debts has been limited by the recent rout in oil and metals prices. Last week, the International Monetary Fund cut its medium-term forecast for growth in emerging markets. After averaging an annual growth rate of about 6.5pc between 2008 and 2014, it is now expected to average 5.2pc a year between 2015 and 2020.

“The decline is the result of population ageing, structural constraints affecting capital growth and lower total factor productivity growth as these economies get closer to the technological frontier,” the IMF said.

Demographics a vital to a nation’s prosperity, and the “demographic window” is when the proportion of working-age people is at its peak. Lasting up to 40 years, it is characterised by a young workforce, a small proportion of retired people and often a fall in birth rates. There are many countries that currently fit this bill.

But a demographic advantage is not enough. Many countries in the Middle East and Africa remain, sensibly, off the agenda for most private investors because of other factors. A badly run country or one with civil strife is unlikely to fulfil its potential.

But emerging markets are not a homogenous entity. So an investor wanting to go into these markets – in what is today essentially a contrarian play – should get more specific than simply investing in a broad-based emerging market fund.

Investors need to be cautious because emerging markets encompass many large oil and metal-exporting countries, which is likely to hit the performance of a fund. Some oil companies are likely to have to renegotiate their borrowings after the falling price of crude slashed cash flows. If crude prices stay subdued for long, finances are at risk.

One country that offers great potential but has two major investment headaches is Nigeria. A staggering 43pc of its population is under the age of 15, with just 3pc aged 65 or over. So demographically it looks good. But Nigeria likely to be held back by its oil exposure and issues with governance and corruption.

Like the “Brics” of Brazil, Russia, India and China, Nigeria’s large population could sustain a consumer boom. However, violence during elections last month left hundreds of people dead, religious conflict between the mainly Muslim north and Christian south continues – and terrorist group Boko Haram stokes significant fear.

Oil companies are currently withdrawing from the Niger Delta after years of violence and oil thefts. At the end of March, Royal Dutch Shell sold its oil lease in Nigeria’s eastern Niger River delta for $1.7bn, as it reduces exposure to the volatile region.

However, for investors wanting to take a long-term view, there are other areas that warrant further research.

One of the most interesting is emerging Asia, which looks a better bet than Latin America, Africa or central and Eastern Europe. However, indices in China and Hong Kong have recently gone ballistic. A new Hong Kong-Shanghai trading link has been established and this has caused money to pour into Hong Kong equities.

So over the longer term it might pay to have a contrarian look east. But, if you do, expect a hair-raising ride.

Garry White is the chief investment commentator at Charles Stanley

Source: http://www.reuters.com/