Emerging market investment returns are likely to outperform those in the developed markets again in 2011, despite facing significant inflation risks and tighter monetary policy, a report published in the Economic Times of India said.
"The cyclical pressures on emerging economy inflation are stronger than in the developed economies, and the recent acceleration in global food prices (equivalent in magnitude since May to the sharp increase in 2007–2008 ) has imparted further inflationary impetus. Chinese inflation, for example, has accelerated to 5.1% from around zero a year ago. While we regard inflation risk in emerging economies as significant, we do not expect it to accelerate substantially from here: cyclical pressures are not yet sufficiently strong and food price inflation is unlikely to accelerate.
The macro background is, nevertheless, consistent with a further tightening in monetary policy in many emerging economies during 2011. This, in turn, is likely to lead to additional appreciation in emerging market currencies relative to developed economy currencies.
The global monetary conditions at present are exceptionally benign, given the low level of real interest rates, and monetary policy is likely to remain stimulative even into 2012. Inflation risks in emerging economies are greater than in the developed economies, and this is already reflected in the tighter monetary conditions in a number of instances, including China, India and Brazil, as well as in many smaller countries. This process is likely to persist in 2011. However, real interest rates in many emerging economies are very low to begin with. We would regard those rate increases which do occur next year as more a "normalisation" of policy rates from these low levels, not a leap to very restrictive monetary conditions.
The recovery in the past 18 months has been significantly more robust in the emerging world than in the developed world. For example, it is likely to take some years before many developed economies recover the output losses realised in the recession. Most emerging economies have already left those milestones behind – to the extent that capacity pressures have now begun to emerge. The fundamentals for emerging growth remain superior: savings ratios are high, budget deficits are low, financial systems are stronger, demographics are more supportive and there is still scope for productivity catch-up with the developed world.
Investment strategy for 2011
Equity multiples in the developed markets are, we estimate, modestly low compared to history. Even in emerging markets, where the rebound has been stronger, multiples are not materially out of line with the longer-term trend.
A similar theme is evident in a range of non-sovereign bond valuations. In our view, these valuations reflect a consensus which is concerned about either a short economic recovery or a weak one. In these circumstances, additional returns to risk assets do not require utopian outturns, rather an environment in which challenging news is simply not quite as challenging as expected.
In some respects, 2011 may feel like a re-run of this year. Equities can grind higher erratically; emerging market equities can outperform modestly rather than spectacularly, partly as a result of currency appreciation; and commodities can make further gains as supply/demand imbalances persist. In short, a further period beckons where it may seem hard to take investment risk. It is, however , likely to pay off."
source - www.island.lk
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