Evaluating Opportunities in Emerging Markets

The past few decades have fostered significant change across emerging markets. The commodity super-cycle along with the emergence of global trade and outsourced manufacturing have resulted in dramatic shifts across these regions.


Edge Capital Research Team


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Merriam-Webster defines “emerge” as “to become known or apparent”. This definition understates the significance of the markets that have been defined as “emerging” by investors. Emerging markets (EM) are increasingly relevant whether measured as a percentage of world GDP or by total market capitalization. Today, there are 800 listed companies in the 21 markets that are considered emerging by MSCI. When small-cap companies are included, the figure increases to 2,600. EM represents nearly 30% of global GDP, compared to 10% in 1988. As a result of this growth, emerging markets’ market capitalization as a percentage of the world is now 13% versus just 1% in 1988, underscoring the relative growth differential and investment opportunities as compared to developed markets.

As emerging markets continue to develop their capital markets, foreign capital available for investment and economic growth has significantly increased. According to the World Bank, global capital flows fluctuated between 2-6% of world GDP from 1980-95. By 2006, global capital flows represented 15% of GDP, or $7.2 trillion.

EM economic and corporate profit growth resulted in tremendous return for EM equity market investors. Over the last three years, however, the S&P 500 outperformed EM by 57% (cumulative). As a result, the market capitalization of various EM indexes as a percentage of GDP (a favorite data point of Warren Buffett) remains at a significant current discount to the US.

In this report, we examine EM growth potential as well as the challenges facing EM investors today and evaluate the opportunities to profit from recent market weakness. We believe there are opportunities for US investors to invest in select emerging market companies which are leveraged to strong economic and corporate profit growth. However, there is great disparity within EM, and we must be mindful of benefits and risks as globalization has introduced greater interconnectivity and more rapid capital flows.