As central banks fail to stimulate growth in Europe, the US and the UK investors are increasingly looking to emerging markets in an attempt to find growth stocks trading at attractive valuations.
Indeed, companies in developed markets are plagued with contracting profit margins, and falling returns on equity as competition heats up and costs rise — a result of higher minimum wage requirements.
With little or no economic growth, companies operating in developed markets are now almost entirely relying on market share growth to increase sales, and this is bad news for the biggest player in every industry.
Emerging markets are still growing and as a result, companies operating in these regions have a tailwind for growth. Emerging markets also have a number of other attractive qualities compared to developed markets. For example, Taiwan is the only market with a net cash position, a breath of fresh air compared to the debt dependent developed world. Further, South Korea is one of the few markets in the world with a rising return on equity.
Of course, the market most investors think of when they think of emerging markets is the Chinese market. However, it’s fair to say that China’s equity market isn’t the most stable market in the world. You need to have an iron temperament and extremely long-term time horizon to invest.
Still, there are signs that the business environment in China could be improving. In a research note sent out to clients at the beginning of this week, Credit Suisse highlighted the fact that MSCI China ROE is starting to grow after five years of declines a sign that public companies may finally be starting to generate a better return for investors.
China’s improving ROE, a positive sign?
According to Credit Suisse, MSCI China ROE has remained flat at 12.4% for three consecutive months, putting an end to more than five years of declines. MSCI China’s ROE has slowed from a peak of 17.2% in November 2011 to its present level.
Analysts believe that firmer commodity prices are to blame for some of this stabilization, but it looks as if MSCI China ROE is steadily improving across the board. MSCI China ROE ex-Financials ex-Energy has risen from a low of 11.8% in November 2015 to 13% currently. Further, the MSCI China ex-Financials ROE has also increased from a recent low of 10.1% to 10.8%.
The one problem with these upbeat figures is the fact that they exclude Financials. The rising value of non-performing loans in China’s financial sector and questions regarding the financial stability of the financial sector in general implies that the slowdown in Financials ROE may offset any pickup in ROE driven by other sectors. Yuan depreciation is yet another variable to consider.