In recent years many investors have boosted their exposure to fast-growing emerging markets, but two Fidelity portfolio managers say that recently the developed markets have looked more appealing.
This doesn't mean that emerging markets do not play a key role in a global portfolio, especially over the long term. A recent Fidelity research paper has forecast that emerging economies will account for an ever-greater share of global growth over the next 20 years.1 In the near term, however, Fidelity portfolio managers Ruben Calderon, co-manager of Fidelity Global Balanced Fund (FGBLX), and Jurrien Timmer, co-manager of Fidelity Global Strategies Fund (FDYSX), say conditions may justify more consideration of developed markets. “The macro backdrop is much healthier in the developed world than in the emerging world,” says Calderon. “Developed markets continue to be the locomotive for the world economy.”
Both Calderon and Timmer say that central bank policies around the world, weakness in China, and other factors make developed markets more appealing than their emerging counterparts.
Quantitative easing programs throughout developed markets, particularly in the U.S. and Japan, have provided considerable support for financial markets. Central bankers’ willingness to backstop their countries’ economies has reassured investors and corporate managers alike. One measure of U.S. corporate sentiment, the Purchasing Managers’ Index (PMI), has increased for six months in a row. Its August reading of 55.7% indicates that the U.S. manufacturing economy continues to expand.2
Federal Reserve Chairman Ben Bernanke first raised the prospect of “tapering” the Fed’s monetary policy initiatives in May, prompting an increase in market volatility, though the Fed held back from reducing bond purchases at the September meeting. For their part, European policymakers continue to signal that they will take all necessary actions to keep the eurozone together. And, the Bank of Japan announced a major quantitative easing program last April, committing to doubling its monetary base over the next two years. Markets responded positively to the prospect of stronger growth in the world’s third-largest economy. “Whenever a central bank makes a really strong policy move, asset prices tend to respond,” says Timmer.
A slowdown in China
Part of the pro–developed markets argument reflects a tilt away from the emerging world. One reason: China’s slowdown. China’s growth has dominated headlines and investment theses for years, but more recently the country’s economy has cooled markedly—from double-digit annual growth as recently at 2010 to an official estimate of 7.5% in 2013.3 This retraction has undercut the resource-based markets, most of them in the emerging world, that until recently benefited from burgeoning Chinese demand. “China is the engine for emerging markets,” Timmer says. “When China’s economy stops growing as fast, that hurts whoever is exporting to China—including suppliers throughout Asia, Latin America, and elsewhere.”
At the same time, emerging markets from Brazil to the Middle East to Russia to Indonesia face political and social troubles that have depressed their growth prospects. “Many countries in the EM complex are seeing increased social risks that could hamper growth in the short term,” says Calderon. “The spontaneous, sudden, and synchronized upheavals we’ve seen recently in some markets are the price you pay for growth.”
Timmer notes that capital flight has exacerbated the emerging-market slowdown. “Emerging markets are far more volatile than developed markets,” he says. “They move around more and they’re more sensitive to capital flows. While, long term, the case for emerging-market growth is in place, in the short term things look like they could be choppy.”
Opportunities in developed markets
While Timmer and Calderon see the potential for challenges in the near future in emerging markets, they see more potential in developed markets, particularly favoring the following stock markets:
The United States
As of the end of July, both Timmer and Calderon held larger-than-benchmark stakes in U.S. stocks relative to their funds’ diversified global benchmarks, because they believe the country offers relatively stable economic growth and will continue to play a role as a financial safe haven. “The U.S. is currently the most attractive equity market in the world,” Calderon says.
Timmer notes that his U.S. emphasis is the logical result of what he describes as a “China weakness” thesis. “Emphasizing the U.S. relative to emerging markets has been an important trend to spot,” he says.
Japan has struggled with deflationary pressures and weak economic growth for more than two decades, during which policymakers have seemed powerless to right the economy. The big question following the central bank’s bold recent move: Is Japan finally doing what it takes to jump-start its economy? Calderon thinks so. His fund’s position in Japanese equities as of July 31 was due in part to his assessment that the policymakers in office now have the will and the ability to improve the economy. “Prime Minister Shinzo Abe is having his Reagan moment—he’s trying to revive the economy at a time when I think the country’s sentiment may be low,” he says.
Calderon notes that Abe is fighting some significant headwinds, not least of which are his country’s aging population and low birthrate. But Calderon sees several bright spots, including Abe’s emphasis on higher education. “He’s working on getting more people to enter universities, to increase Japan’s ability to exchange intellectual assets with its partners in the developed world,” Calderon says.
Europe’s financial crisis has dominated headlines about the continent for at least two years. Concerns about Europe’s financial situation obscure a strong investment case for the region’s stocks, according to Calderon. “Europe’s crisis is a liquidity crisis; it’s not a solvency crisis. That’s a major distinction,” he says. “There will be additional crises and scares in the future. But I don’t think that calls for an underweight to the region, especially when many European companies still have reasonable fundamentals and growth.”
Calderon notes that strong trade relations between Europe and the United States buttress European companies. He points out that over the past five years, U.S. foreign direct investment has created more jobs in Europe than in China. And, as in Japan, positive actions by policymakers have stabilized the European economy. “I think the investment world has gotten Europe wrong until recently,” says Calderon. “Investors minimized the importance of the policymakers, and underestimated their determination to hold the eurozone together.”
An ever-shifting global landscape
The complex dynamics of an interconnected global economy mean that investors must look worldwide for opportunities to capture growth, enhance diversification, and adjust to changing circumstances. Emerging markets, which offer stronger long-term growth prospects than developed markets, play an important role. Even now, Timmer and Calderon are finding opportunities in select emerging markets, despite the headwinds faced by the EM complex as a whole. But, for the time being, investors may want to emphasize the developed world, where the macroeconomic backdrop appears more likely to support healthy stock-market returns.