It’s risk-on again for emerging markets

In a recent webinar, he predicted 2012 will be a strong year for emerging market equities, basing his forecast on the improved tone of data.

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“Monetary policy easing has started in a number of emerging markets and inflation is rolling over in a number of these markets,” he said. “We are starting to see much better than expected economic reports.”

Inflation in China, for instance, peaked at an annualized rate of 6.2% in August 2011, before falling to 4.5% in January this year. If China can successfully combine slower growth and inflation with rising consumer demand it could be as close “to Nirvana as you might get.”

Mesburis added: “There are some strong hints of this already in [China’s] Q4 GDP report that came out in January.”

Emerging once more: Read or listen

At 8.9%, China’s GDP growth was its weakest in over two years, but it is argued that it was better than expected.

“Another point for all the ‘China bubble’ watchers is that official Chinese estimates now show that just over 50% of the population is urbanized,” said Mesburis. “Many forecasters expect the figure to move to 70% by the end of this decade.”

A similar trend can be seen across all emerging markets.

Read: Profit from the emerging middle class

Detractors often argue that macroeconomic indicators don’t always translate to upticks in equity markets, and 2011 proved that point. This year, however, emerging market equities are off to a great start.

“Emerging markets as a whole are up 12% on a year-to-date basis versus 3.5% for the TSX,” said Mesburis. “We believe that the valuations are quite attractive, the forward P/E multiples are about 10 times—well below their long-term averages—and we expect continued growth coming out of the EM space.”

Positive fund flows in recent weeks indicate investor sentiment has rebounded, he added. Some of the risks that dragged emerging markets down last year are expected to recede.

Read: Emerging market inflows soar

“For 2012, the key catalysts will be monetary policy easing and a containment of European sovereign debt crisis,” said Mesburis. “[Unlike their industrialized counterparts], emerging economies still have many more policy bullets that they can utilize.”

Having raised interest rates over the last couple of years to curb inflation, emerging markets are now focusing on lowering rates.

The Central Bank of Brazil was the first to reverse course when it embarked on a series of interest-rate cuts that started last August. It has already cut its benchmark rate three times, reducing it from 12.5% to 10.5%.

In another sign of monetary easing, key central banks in emerging markets have lowered their cash reserve ratio and are widely expected to continue to do so. The People’s Bank of China cut the reserve ratio for its banks by 50 basis points in December. Misburis points out that at 21% it is still quite high, providing ample room for further easing.

The Reserve Bank of India also reduced its cash reserve ratio by 50 basis points to 5.5% and signalled future rate reductions.

But one the strongest arguments for the future of emerging markets equities lies in the past. “Historically, equities are known to rally after central banks ease monetary policy,” said Mesburis.

“We expect further easing across emerging markets [as they] grow at about 5.1% in 2012 and 6% in 2013, compared to industrialized countries which are expected to grow 0.9% and 1.3% respectively.”

Led by China and India, Emerging markets contributed to about 70% of global GDP growth in 2011. The number is expected to increase to 76% in 2012. “We expect China and India to continue to lead emerging market growth in coming years.”