• Print
  • Default text size A
  • Larger text size A
  • Largest text size A

Can emerging markets stage a turnaround?

The risks in emerging markets may already be priced in, say our investing leaders.

With investor concerns focused on tensions in the Ukraine , a slowing Chinese economy, and broad emerging-market weakness, Fidelity presidents, chief investment officers, and other leaders within the investment divisions at Fidelity gathered to discuss whether these and other risks could spark a global market crisis.

Veteran emerging markets fund manager John Carlson views the recent pullback as “more of an adjustment than a crisis,” but warns that security selection in this environment gets much trickier. “We are entering an ‘age of bifurcation,’ when it will take superior research and analysis to ferret out the winners from the losers.”

Here are excerpts from the far-ranging discussion, moderated by Jacques Perold, President of Fidelity Management & Research Co. [Note: The following views represent those of one or more individuals, and should not be considered as the collective view of either Fidelity Investments or any particular investment division.]

The big picture

Jacques Perold (Moderator): Should investors be concerned about emerging markets?

John Carlson (Emerging-Market Debt): I would characterize what’s currently happening in emerging markets as more of an adjustment than a crisis. Emerging-market sovereigns are generally in much better shape from a balance sheet/cash flow perspective than they were 30 years ago. Since 1982-83, the wind has been at the backs of these countries. By and large, there has been a massive decline in global interest rates, an increase in commodity prices, a significant rise in global trade, and growth in consumer middle-class populations. In addition, there’s been a decline in foreign currency debt (as a percentage of GDP), and a massive rise in foreign exchange reserves (as a percentage of GDP) (see chart below). Today, fewer countries have fixed exchange rates. These developments illustrate how emerging-market countries are more stable now from a sovereign debt standpoint than during previous crises.

Perold: Are you saying investors shouldn't be alarmed?

Carlson (Emerging-Market Debt): I’m not saying there couldn't be individual countries that may experience a debt crisis—there are still some significant geopolitical risks in certain countries, such as Ukraine, Argentina, Venezuela, and Turkey. A debt crisis, can, in fact, be healthy over the long term. But the overall financial health among many emerging markets is more stable than it was in the past, and I think the likelihood of a local debt problem becoming a systemic problem is diminished.

With the growth of the capital markets over the past several decades, there has been a restructuring of bank loans, the issuance of hard currency, and the increased development of local currency instruments. Emerging-market sovereigns are less indebted today and have moved more of their debt into local currency, mainly because of the rise of the consumer middle class—a population that needed investment/savings vehicles, insurance, and mortgages, all of which required the development of local capital markets.

Perold: Are we a long way from the currency mismatch crises that occurred in the 1990s?

Carlson (Emerging-Market Debt): Yes—a crisis is harder to find today among many sovereigns.

Joseph Desantis (Equities): Given the buildup of local debt-market borrowing, I do think it’s possible there could be a local sovereign crisis due to an internal issue, such as credit deterioration due to slower economic growth and efforts to raise rates to combat inflation.

Bill Bower (International Equities): Yes, I think we are a long way off from a crisis, and I would argue that it’s easier to analyze those local crises today via traditional economics (through current account deficits or surpluses). Many sovereigns are in much better financial shape, so the currency mismatch isn’t as bad as it was in the 1990s, when some countries went bankrupt overnight because they had primarily U.S.-dollar-denominated liabilities (e.g., Asian financial crisis, 1997).

Desantis (Equities): I agree. I think you can analyze a potential crisis situation better if it is more localized—and today it is less likely to have that global effect in which other countries are impacted when their access to capital is pulled by foreign and local investors, which is what happened in the 1990s. There can be a clearer delineation of country fundamentals, which can separate, rather than concentrate, all borrowers in one category.

Matt Torrey (Emerging-Market Debt and Equity): One important point John Carlson is alluding to is that the yield curve in many countries is a lot longer than it used to be. Many countries used to only have the ability to issue very short-term debt (e.g., Mexico in 1994). Those issues still exist to some extent in certain countries, but yield curves in many other countries have gotten longer as local investor pools have become larger.

So sovereigns are less indebted in foreign currencies. Locally, sovereigns generally have much longer yield curves, making the previous debt) rollover problem a much less significant issue. For example, today, Mexico can issue a 100-year bond; that shows the country has come a long way from the 1994 crisis.

Perold: What about the significant presidential and parliamentary election calendar in 2014?

Bob von Rekowsky (Emerging-Market Equity): Emerging markets face an array of election challenges in 2014, with the potential for both optimism and disappointment in regard to necessary structural reforms. The first half of the year is particularly significant, with general elections in South Africa (April), parliamentary and presidential elections in Indonesia (April and July, respectively), parliamentary elections in Hungary (April), presidential elections in Colombia (May), and general elections in India (May). In 2014, presidential elections will be held in Turkey (August) and Brazil (October), two countries whose economic management have been the subject of street protests by unhappy constituents. This could be a catalyst for higher emerging-market volatility as the year progresses. That said, our previous studies of elections suggest that markets tend to underperform during the three to six months prior to an election amid policy uncertainty, and recover thereafter—regardless of the political stripe of the winning party.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Although the bond market is also volatile, lower-quality debt securities including leveraged loans, generally offer higher yields compared to investment-grade securities, but also involve greater risk of default or price changes. The securities of smaller, less well-known companies can be more volatile than those of larger companies. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. Sector investments can be more volatile because of their narrow concentration in a specific industry.
Views expressed are based on the information available as of Mar. 21, 2014, and may change based on market and other conditions.
There is no guarantee the trends discussed will continue.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
Past performance is no guarantee of future results.
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
It is not possible to invest directly in an index. All indices are unmanaged.
Information presented is for informational purposes only and is not intended as investment advice or an offer of any particular security. This information must not be relied upon in making any investment decision. Fidelity cannot be held responsible for any type of loss incurred by applying any of the information presented. Content has been provided for informational purposes only and should not be considered investment advice or an offer for a particular security or securities. These views should not be relied on as investment advice, and because Fidelity’s investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product or service. Fidelity does not assume any duty to update any of the information. Fidelity cannot be held responsible for any direct or incidental loss incurred by applying any of the information offered. An individual’s investment decisions should take into account the unique circumstances of the individual investor. Please consult your tax or financial advisor for additional information concerning your specific situation.
All indices are unmanaged, and performance of the indices includes reinvestment of dividends and interest income, unless otherwise noted, are not illustrative of any particular investment, and an investment cannot be made in any index.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed-income security sold or redeemed prior to maturity may be subject to loss. Duration is a measure of a security’s price sensitivity to changes in interest rates. Duration differs from maturity in that it considers a security’s interest payments in addition to the amount of time until the security reaches maturity, and also takes into account certain maturity shortening features (e.g., demand features, interest-rate resets, and call options), when applicable. Securities with longer durations generally tend to be more sensitive to interest-rate changes than securities with shorter durations.
The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Neither diversification nor asset allocation ensures a profit or guarantees against a loss.
Standard deviation: a mathematical formula for the average distance from the average; how much variation there is from an average or norm.
1. Source: Fidelity Investments, as of Feb. 28, 2014.

2. Source: Haver Analytics, Fidelity Investments, as of Jan. 31, 2014.

3. Source: Bloomberg, Credit Suisse, as of Feb. 2014.

4. Source: “China’s forex reserves reach $3.4tn,” www.ft.com, Apr. 11, 2013.

5. Source: “Russia Surprises With Rate Hike as Ruble Plunges,” www.foxbusiness.com, Mar. 3, 2014.

6. Fidelity Investments, as of Mar. 31, 2014.

7. The European Commission, Countries and Regions: Russia, Nov. 19, 2013.

8. Bloomberg, Fidelity Investments, as of Mar. 21, 2014.
Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
680123.4.0

Bonds

Perold: What about corporate debt in emerging markets?

Carlson (Emerging-Market Debt): The increase in global trade has been a huge benefit to the corporate sector, but I think investors need to spend more time analyzing corporate issuers, because there are more risks to be concerned about. Many corporates have borrowed in U.S. dollars, and, unlike a lot of sovereigns, this can lead to a currency mismatch against their revenues in local markets. In addition, many of these corporations have never experienced a rising-interest-rate environment. So, if the rising-interest-rate environment continues, the combination of a currency mismatch and inexperienced management on the corporate side could lead to pressure on corporate profit margins. This is a considerable risk for some companies. After a period of significant secular growth within emerging markets, I think we’ve entered an “age of bifurcation,” meaning that going forward it will take superior research and analysis to ferret out the winners from the losers within each emerging market.

Bob von Rekowsky (Emerging-Market Equity): Many corporates today have access to a steady flow of foreign exchange—either from their operations or their subsidiaries abroad—so it’s less likely for them to experience a situation where their access to capital suddenly dries up. In previous crises, a sovereign would restrict access to foreign exchange, and then the corporates often “fell on the other side” of the access-to-foreign- exchange barrier.

James Hayes (Emerging-Market Equity): Emerging-market private sector debt has grown (to a ratio of ~100% of GDP), although it still trails leverage levels in developed markets (currently at ~160% of GDP)—see chart, below. But there has been a significant increase in emerging-market debt, and much of the increase has occurred during the past five years. Typically, an increase in debt of that magnitude precedes a period of retrenchment, or in certain markets, a crisis.

Perold: Has the Fed's tapering policy influenced emerging-market debt?

Carlson (Emerging-Market Debt): I think the Fed’s tapering is, for the most part, already priced into emerging-market debt. The U.S. is still in a deflationary cycle—labor is cheap, technology innovation continues to boost productivity, and capacity utilization is slightly below the long-term average. The broader emerging-market debt market initially got scared back in the spring of 2013 when it got wind of Fed tapering, and many debt securities were repriced. My rule of thumb is that emerging-market debt flows tend to follow the direction of short-term U.S. Treasury rates, and thus I think there is a difference in how you interpret the significance of tapering (reducing asset purchases) vs. tightening (raising interest rates). Since 2000, both short- and long-term rates have been in a secular decline. Based on fed funds futures, the market is predicating now that five-year Treasury bond yields are going to increase to 4.5% in five years.1 In my view, I think that significant a move is unlikely.

Perold: What else should investors keep in mind?

Angelo Manioudakis (Global Asset Allocation): We took a look at the bonds of the weaker companies in the universe and tried to evaluate them under the assumption that they were not rated properly and the rating agencies were being too optimistic. Even assuming a downgrade for these securities, the emerging-market debt universe didn’t appear to be too expensively valued overall. In other words, the market is already fully pricing in lower future ratings.

Carlson (Emerging-Market Debt): It’s important to consider what could go wrong with any debt security assessment—and that’s a default. If a country defaults on its debt obligations, I would hope the structural improvements seen in these markets during the past decade or more would help minimize the contagion, but historically there has always been some contagion.

Most of the investors today have not been around long enough to experience a sovereign default. Historically, there always seems to be a white knight—a state, an institutional buyer, or the International Monetary Fund (IMF)—that comes along and backs the country’s debt with capital and is willing to save the issuer. If something does go wrong that leads to a default that can’t be contained, it will likely be a political issue that few people could have predicted.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Although the bond market is also volatile, lower-quality debt securities including leveraged loans, generally offer higher yields compared to investment-grade securities, but also involve greater risk of default or price changes. The securities of smaller, less well-known companies can be more volatile than those of larger companies. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. Sector investments can be more volatile because of their narrow concentration in a specific industry.
Views expressed are based on the information available as of Mar. 21, 2014, and may change based on market and other conditions.
There is no guarantee the trends discussed will continue.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
Past performance is no guarantee of future results.
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
It is not possible to invest directly in an index. All indices are unmanaged.
Information presented is for informational purposes only and is not intended as investment advice or an offer of any particular security. This information must not be relied upon in making any investment decision. Fidelity cannot be held responsible for any type of loss incurred by applying any of the information presented. Content has been provided for informational purposes only and should not be considered investment advice or an offer for a particular security or securities. These views should not be relied on as investment advice, and because Fidelity’s investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product or service. Fidelity does not assume any duty to update any of the information. Fidelity cannot be held responsible for any direct or incidental loss incurred by applying any of the information offered. An individual’s investment decisions should take into account the unique circumstances of the individual investor. Please consult your tax or financial advisor for additional information concerning your specific situation.
All indices are unmanaged, and performance of the indices includes reinvestment of dividends and interest income, unless otherwise noted, are not illustrative of any particular investment, and an investment cannot be made in any index.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed-income security sold or redeemed prior to maturity may be subject to loss. Duration is a measure of a security’s price sensitivity to changes in interest rates. Duration differs from maturity in that it considers a security’s interest payments in addition to the amount of time until the security reaches maturity, and also takes into account certain maturity shortening features (e.g., demand features, interest-rate resets, and call options), when applicable. Securities with longer durations generally tend to be more sensitive to interest-rate changes than securities with shorter durations.
The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Neither diversification nor asset allocation ensures a profit or guarantees against a loss.
Standard deviation: a mathematical formula for the average distance from the average; how much variation there is from an average or norm.
1. Source: Fidelity Investments, as of Feb. 28, 2014.

2. Source: Haver Analytics, Fidelity Investments, as of Jan. 31, 2014.

3. Source: Bloomberg, Credit Suisse, as of Feb. 2014.

4. Source: “China’s forex reserves reach $3.4tn,” www.ft.com, Apr. 11, 2013.

5. Source: “Russia Surprises With Rate Hike as Ruble Plunges,” www.foxbusiness.com, Mar. 3, 2014.

6. Fidelity Investments, as of Mar. 31, 2014.

7. The European Commission, Countries and Regions: Russia, Nov. 19, 2013.

8. Bloomberg, Fidelity Investments, as of Mar. 21, 2014.
Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
680123.4.0

China and Ukraine

Perold: Has the slowdown in China’s economy contributed to increased volatility in emerging markets?

Carlson (Emerging-Market Debt): I think it has been a factor, but my personal view is that investors generally have become far too concerned on what will happen with China. When you look at where the world’s growth has been coming from, China’s contribution is smaller than the combined contribution of Europe, the U.S., and the rest of the emerging-market universe, and it has been dwindling during the past five years (see chart right). So, in my view, the decline in China’s growth is not as big a factor in terms of global GDP as some may consider. China is trying to shift from an export-driven economy to a local consumer-driven economy, and that will likely result in a lower expected annual GDP growth, in the range of 5% to 7% going forward. China has had a pretty good 35-year run of exceptional annual growth above most countries. Let’s applaud them and move on. The global GDP breakdown shows there is a movement toward more balance from various countries in terms of their contribution, and I believe China’s contribution may even be less next year.

Hayes (Emerging-Market Equity): From my perspective, the expectation that China will continue to be a growth driver of emerging-market economies over the next decade is unlikely. China’s overinvestment in directive lending has peaked relative to the country’s GDP. There is a large percentage of vacant housing stock. Housing prices on average remain elevated, and housing affordability for the average consumer is well above levels in other major cities outside China. The best-case scenario is one of gradual deleveraging, and the country eventually using a large portion of its reserves to bail out the banks. In addition, China is likely to gradually devalue its currency, the renminbi. In my view, the risks of some type of hiccup in China’s financial markets are not insignificant.

von Rekowsky (Emerging-Market Equity): The last time China faced an Asia slowdown, it held its currency firm and didn’t devalue it—and the country really took it on the chin. Because China stated its intent to move its economy to a more consumption-based rather than an investment- and export-led economy over the next 10 to 15 years, its trade balances will likely shrink and eventually go negative. When a country goes from net exports to net imports, it becomes a drag on GDP—and that’s what likely contributes to a lower 5% to 7% GDP growth rate for China going forward.

Hayes (Emerging-Market Equity): Global growth is becoming more balanced, with emerging-market growth slowing and with developed markets slightly accelerating. At the same time, it’s important to note that emerging-market growth overall is still stronger than developed-market growth. Emerging-market countries had lost some competitiveness over the past decade through real currency appreciation.2 During the past year, however, several of these markets have seen fairly significant foreign-exchange depreciation. As a result, for many emerging- market countries outside of China, current account deficits are improving off trough levels—both in aggregate and in some of the so-called “problem” markets, such as South Africa, Turkey, and India.3 I think the wheels are in motion in terms of a readjustment process in emerging markets.

Perold: What sectors should investors be monitoring in China?

von Rekowsky (Emerging-Market Equity): One of the concerns is what do you do with the stocks of large Chinese banks, which look cheap on a price-to-earnings and price-to-book basis. It’s sort of the elephant in the room.

Hayes (Emerging-Market Equity): I agree—the banks are worth watching. With the approximately $3 trillion in U.S. dollar reserves that China has, I think the country’s goal is to implement a managed process whereby the reserves serve as a backstop for the banks’ problems in the trust and wealth management area.4 These Chinese banks have very big, highly leveraged balance sheets. Some of the projects are healthy, including urban subways and other transportation development. But much of the lending has financed bad projects, such as real estate development in what are being referred to as “ghost cities,” where there is already a large housing stock that is vacant. So the key question is how these banks work off the bad investments without burning through their capital.

Perold: What about the political unrest in Russia and Ukraine?

von Rekowsky (Emerging-Market Equity): Tensions in the region have led to volatility in debt, equity, and commodity markets. The recent volatility of the ruble and the 150-basis-point interest-rate hike5 challenge an already-lackluster economic outlook for Russia; these factors have weighed heavily on Russia’s stock market so far in 2014, and even before the Ukraine crisis contributed to investor concern. In addition, the White House is saying investments could come under additional pressure from U.S. and European Union (EU) sanctions. This could be particularly challenging for Russian energy and financial services companies, for example. In reality, however, Russian state-controlled gas company Gazprom supplies an estimated 26% of European natural gas, which includes nearly 40% of Germany’s annual natural gas needs.6 In addition, the EU is the most important investor in Russia—an estimated 75% of foreign direct investment in Russia comes from EU-member states.7

At present, Ukraine is viewed as a solvent sovereign credit, but it faces significant liquidity issues. Longer term, however, if structural reforms are not addressed—such as improved fiscal and energy policies—Ukraine faces further deterioration in its economic profile, putting it at a higher risk of economic downgrade and default.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Although the bond market is also volatile, lower-quality debt securities including leveraged loans, generally offer higher yields compared to investment-grade securities, but also involve greater risk of default or price changes. The securities of smaller, less well-known companies can be more volatile than those of larger companies. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. Sector investments can be more volatile because of their narrow concentration in a specific industry.
Views expressed are based on the information available as of Mar. 21, 2014, and may change based on market and other conditions.
There is no guarantee the trends discussed will continue.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
Past performance is no guarantee of future results.
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
It is not possible to invest directly in an index. All indices are unmanaged.
Information presented is for informational purposes only and is not intended as investment advice or an offer of any particular security. This information must not be relied upon in making any investment decision. Fidelity cannot be held responsible for any type of loss incurred by applying any of the information presented. Content has been provided for informational purposes only and should not be considered investment advice or an offer for a particular security or securities. These views should not be relied on as investment advice, and because Fidelity’s investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product or service. Fidelity does not assume any duty to update any of the information. Fidelity cannot be held responsible for any direct or incidental loss incurred by applying any of the information offered. An individual’s investment decisions should take into account the unique circumstances of the individual investor. Please consult your tax or financial advisor for additional information concerning your specific situation.
All indices are unmanaged, and performance of the indices includes reinvestment of dividends and interest income, unless otherwise noted, are not illustrative of any particular investment, and an investment cannot be made in any index.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed-income security sold or redeemed prior to maturity may be subject to loss. Duration is a measure of a security’s price sensitivity to changes in interest rates. Duration differs from maturity in that it considers a security’s interest payments in addition to the amount of time until the security reaches maturity, and also takes into account certain maturity shortening features (e.g., demand features, interest-rate resets, and call options), when applicable. Securities with longer durations generally tend to be more sensitive to interest-rate changes than securities with shorter durations.
The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Neither diversification nor asset allocation ensures a profit or guarantees against a loss.
Standard deviation: a mathematical formula for the average distance from the average; how much variation there is from an average or norm.
1. Source: Fidelity Investments, as of Feb. 28, 2014.

2. Source: Haver Analytics, Fidelity Investments, as of Jan. 31, 2014.

3. Source: Bloomberg, Credit Suisse, as of Feb. 2014.

4. Source: “China’s forex reserves reach $3.4tn,” www.ft.com, Apr. 11, 2013.

5. Source: “Russia Surprises With Rate Hike as Ruble Plunges,” www.foxbusiness.com, Mar. 3, 2014.

6. Fidelity Investments, as of Mar. 31, 2014.

7. The European Commission, Countries and Regions: Russia, Nov. 19, 2013.

8. Bloomberg, Fidelity Investments, as of Mar. 21, 2014.
Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
680123.4.0

Stocks

PEROLD: What are the near-term prospects for emerging-market equities?

Hayes (Emerging-Market Equity): I think we’re in the seventh inning of this current period of turmoil for emerging-market equity. The stabilization and the rebalancing have already started to happen, and it should continue. As a result, the imbalances we’ve identified today should normalize over time. Stocks are cheap. They could get a bit cheaper, rates could go a bit higher, and foreign exchange could weaken a bit further. Overall though, given where equity valuations are (10x forward EPS) relative to developed-market equities (14.5x forward EPS)8—the biggest gap during the past 10 years—I think emerging-market equity should be viewed as a “buy” on weakness opportunity over the next 12 months as opposed to a “sell” into strength opportunity.

von Rekowsky (Emerging-Market Equity): Some market participants have suggested that equities are cheap and now is the time to buy, but I’m not sure that makes sense as a strategy across the board. During the past three years, some equity sectors have performed fairly well and are now relatively expensive, and others that have fared poorly became even cheaper on a price-to-earnings basis. Realistically, sector performance often has been linked to the overall equity market returns among certain countries when those sectors have hefty weightings. For example, the markets of commodity-exporting countries have performed poorly in recent years, and so have the commodity sectors in those countries, such as energy and materials. In other areas, such as technology and consumer staples, returns have been relatively better.

If you look at price-to-book valuations on a sector-adjusted basis, the equity market hasn’t gotten anywhere close to as cheap as it was in 2001–2002 relative to developed markets (see chart, below), implying that emerging-market equity has a way to go before it’s seen as really cheap overall. Stock selection has been critical to relative returns amid the recent volatility, and will continue to be. I think it’s more important to determine if you are investing in a good business. One area of concern overall is that earnings growth is generally still declining, particularly in Latin America. So although valuations are cheaper, earnings on average may still not have hit bottom. I don’t think valuations will decline to previous crisis levels, but the broader equity market is back near its long-term average in terms of valuation.

Desantis (Equities): Everybody loved emerging-market equities for about a decade. The asset class generally performed quite well, and the appreciation was driven by strong demand for commodities and a big move in Chinese banks to rich valuations of book value. On a cap-weighted basis, the emerging-market equity market overall is near a trough in valuations relative to the group’s history, but on a median basis across sectors, valuations are about average overall. To Bob’s (von Rekowsky’s) point, the asset class is cheap but not dirt cheap, and if you want to buy equities that are really cheap, you have to look at materials, financials—sectors that have been really beaten up more recently. However, when looking at the fundamentals within those inexpensive areas, we don’t see many obvious investment opportunities. So, our portfolio managers are being patient and selective as they look for companies with the potential for longer-term growth. Over the next decade, it is likely growth in these markets will be driven by different industries than what drove the asset class during the past cycle.

von Rekowsky (Emerging-Market Equity): My suggestion would be to avoid simply investing in what is cheap, try to determine which companies are growing and likely to keep growing, and to maintain positions in those companies that are successfully gaining international market share and expanding their domestic sales. Such stocks may be viewed as somewhat expensive right now, but I think it may be an appropriate approach at this point in the emerging-market cycle. One additional consideration: If the U.S. equity markets continue to outperform the rest of the world, that likely means the U.S. dollar may strengthen relative to foreign currencies, which is a potential headwind for emerging-market equity. It also is a headwind for commodities and commodity-exporting companies.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Although the bond market is also volatile, lower-quality debt securities including leveraged loans, generally offer higher yields compared to investment-grade securities, but also involve greater risk of default or price changes. The securities of smaller, less well-known companies can be more volatile than those of larger companies. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. Sector investments can be more volatile because of their narrow concentration in a specific industry.
Views expressed are based on the information available as of Mar. 21, 2014, and may change based on market and other conditions.
There is no guarantee the trends discussed will continue.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
Past performance is no guarantee of future results.
Investing involves risk, including risk of loss.
Diversification does not ensure a profit or guarantee against loss.
It is not possible to invest directly in an index. All indices are unmanaged.
Information presented is for informational purposes only and is not intended as investment advice or an offer of any particular security. This information must not be relied upon in making any investment decision. Fidelity cannot be held responsible for any type of loss incurred by applying any of the information presented. Content has been provided for informational purposes only and should not be considered investment advice or an offer for a particular security or securities. These views should not be relied on as investment advice, and because Fidelity’s investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product or service. Fidelity does not assume any duty to update any of the information. Fidelity cannot be held responsible for any direct or incidental loss incurred by applying any of the information offered. An individual’s investment decisions should take into account the unique circumstances of the individual investor. Please consult your tax or financial advisor for additional information concerning your specific situation.
All indices are unmanaged, and performance of the indices includes reinvestment of dividends and interest income, unless otherwise noted, are not illustrative of any particular investment, and an investment cannot be made in any index.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed-income security sold or redeemed prior to maturity may be subject to loss. Duration is a measure of a security’s price sensitivity to changes in interest rates. Duration differs from maturity in that it considers a security’s interest payments in addition to the amount of time until the security reaches maturity, and also takes into account certain maturity shortening features (e.g., demand features, interest-rate resets, and call options), when applicable. Securities with longer durations generally tend to be more sensitive to interest-rate changes than securities with shorter durations.
The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Neither diversification nor asset allocation ensures a profit or guarantees against a loss.
Standard deviation: a mathematical formula for the average distance from the average; how much variation there is from an average or norm.
1. Source: Fidelity Investments, as of Feb. 28, 2014.

2. Source: Haver Analytics, Fidelity Investments, as of Jan. 31, 2014.

3. Source: Bloomberg, Credit Suisse, as of Feb. 2014.

4. Source: “China’s forex reserves reach $3.4tn,” www.ft.com, Apr. 11, 2013.

5. Source: “Russia Surprises With Rate Hike as Ruble Plunges,” www.foxbusiness.com, Mar. 3, 2014.

6. Fidelity Investments, as of Mar. 31, 2014.

7. The European Commission, Countries and Regions: Russia, Nov. 19, 2013.

8. Bloomberg, Fidelity Investments, as of Mar. 21, 2014.
Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
680123.4.0

Related Articles

  • Market update

    Seesaw trading accentuates tumultuous summer. Here’s a look at what’s happening now.

  • 7 things to know now

    Why this isn’t likely the start of a bear market, but volatility may be here to stay.

  • Pullback in perspective

    Get insight from our experts on the market outlook and opportunities ahead.

  • Global tug of war

    Developed markets look healthy, emerging markets look weak, says a Fidelity expert.

View all Markets articles

Viewpoints on the iPad

Get our latest articles, and manage your portfolio and deposit checks.

Download the Fidelity iPad App.