Emerging Markets vs Developed Markets

While market falls can be unsettling, they can present unique investment opportunities. The key question is which markets will deliver growth from now on - and we believe it is a compelling time to consider emerging markets equities.

It may surprise UK readers to know that policies in emerging markets have generally been more orthodox and conventional than developed markets recently. We believe this has led to more robust economies relative to their own history - and relative to developed markets.

Since the global financial crisis in 2008, emerging economies avoided experiments with negative interest rates. And during the recent pandemic, policymakers in emerging markets generally did not pursue overly aggressive fiscal support plans, which means they did not blow up their balance sheets.

This contrasts starkly with developed markets like the United Kingdom, for example, which  has enacted very aggressive fiscal expansions and a disastrous economic experiment that, most recently, led to Liz Truss’s doomed 45-day premiership and market turmoil.

In addition, emerging economies are typically less indebted at the sovereign, corporate and household levels. In Mexico, for example, the household debt-to-gross domestic product (GDP) ratio is 16%, compared with the United Kingdom’s ratio of around 90%.²

Relatively Low Debt-to GDP Ratios in Emerging versus Advanced G20 Economies

Debt (General Government Gross) to GDP Ratio*
2001-2025E

*Weighted Average based on PPP (Purchasing Power Parity) GDP Weights; as of August 8, 2022. Argentina is excluded from emerging economies due to non-availability of forecast. Calculations by Franklin Templeton’s Global Research Library with data sourced from FactSet, International Monetary Fund. Important data provider notices and terms available at www.franklintempletondatasources.com .

In addition, emerging market equity valuations are trading at near historic discounts versus the developed world. In our analysis, the relative profitability between these two asset classes does not warrant the current 45% discount.³

And relative to its own 15- to 20-year history, emerging markets as an asset class is one of the few that looks cheap to us. The MSCI Emerging Markets (EM) Index, a benchmark representing the asset class, is now trading at close to 10 times forward earnings of its constituent companies, compared to around 18 times for the US S&P 500 Index (S&P 500).⁴

As a sign of corporate health and balance sheet strength, many emerging market companies have been increasing their dividend payouts. They have been using their cash flows to distribute dividends to shareholders rather than deploying capital in such an uncertain growth outlook.

Company managements have also been seeing value in their equities, resulting in increased share buyback activity. In this volatile environment, however, these dividends and buybacks are appreciated by shareholders, but we do prefer companies invest in their own businesses over the long term to generate growth and strengthen their competitive position.

While we believe the persistence of high dividend levels is unlikely to remain at the current 4% level, there has been a sea change in how emerging market companies think about capital optimisation and balance sheet management.⁵ Over the past 20 years, approximately 2.5% of returns have come from dividends.⁶ so the current; level of dividend support is nearly double the average - which many investors may not realise.

Cautious optimism - we are cautiously optimistic about emerging market economies relative to their developed peers. Despite the current environment of slowing growth, rising inflation and geopolitical issues globally, we have confidence in both the emerging markets asset class and our strategies. We continue to seek high-quality business with solid balance sheets, competitive advantages and attractive valuations.

At the company level, there are opportunities in high-quality and high-growth companies. Emerging markets are home to some of the most innovative, technology-oriented companies in the world—companies that are building the critical digital architecture of the world around us.

These include world-class hardware and software suppliers as well as the leading advanced semiconductor manufacturers.  Some are at the leading edge of the transition to a low carbon future. Many emerging market companies are established global leaders in the production of electric vehicles and electric batteries, and in renewable energy such as in solar manufacturing.