STOCKS in most developed countries have done remarkably well over the last three years and reached their pre-global economic crisis levels of 2008 in many cases. But recovery is weak - very weak and fragile in Europe - and many commentators have begun wondering whether stocks are overpriced, writes Professor Enrico Colombatto.
The fact that stock markets have not dropped significantly so far means that investors think differently from commentators. Investors probably see that many listed companies do business outside Europe and the United States, and that the global economy is relatively healthy.
World gross domestic product (GDP) should grow by 3.5 per cent in 2014, and almost four per cent in 2015, according to the International Monetary Fund.
Stagnation in the West is not necessarily a problem for many large Western public companies, but the fact that the bull market is taking a break also shows that investors are more prudent. The traditional alternative of bonds is not exciting with interest rates likely to remain low.
Low interest rates and expensive Western stocks have generated renewed interest in developing countries. These now have new possibilities to finance fixed-capital investments, upgrade technologies, extend their productive potential and to play increasingly important economic roles on the world stage.
Investors are showing renewed interest in less developed countries (LDCs) because prospects for returns in the West are dim. LDC bonds and shares, in contrast, have become much more liquid over the past few years.
The relative high growth rate of many LDCs helps make their indebtedness sustainable, as long as LDC companies and governments do not take undue advantage of the opportunity to borrow cheaply. Favourable financial conditions, monetary stability and relatively benign regulatory and fiscal regimes - when present - could trigger very significant and profitable entrepreneurial energies.
The IMF predicts that LDC annual growth will be about five per cent - and seven per cent for developing Asia - during the next couple of years. Trade volumes should also increase at the same speed. The overall economic prospects for the less affluent part of the world are promising.
The bad news is that investors will also be more discerning and will keep three elements in mind as they look for LDC investment opportunities.
First, they know that many LDCs are vulnerable to what happens to energy markets, more so than Western countries. India and Turkey seem particularly exposed.
Second, Western investors are aware that political uncertainty remains high in many LDCs. Investors are highly reactive to this as they showed in getting rid of LDC assets after political troubles in Turkey and Brazil in 2013.
Third, regulatory unpredictability also figures prominently on investors’ radars, as people are unwilling to commit themselves to long-term projects if the legal context is vulnerable to populism and corruption. Even if government intervention does not go as far as expropriation, burdensome changes in the tax regime, labour laws or licensing can deeply affect the competitive positioning of a company.
The new wave of investors will have to accept that high yields will correspond to significant risk-taking.
Recipient LDC countries will therefore be dealing with cautious and selective investors who will pay more attention to the political environment and will look for the rule of law, rather than for easy gains.
Investors looking for high returns will be increasingly interested in funding medium-size young firms which have at least a local reputation and need financial resources to take off. Developing good connections between promising companies led by aggressive entrepreneurs and foreign clients and suppliers will be the key to success.
The coming months will offer extraordinary opportunities, from the potential recipients’ perspective, to reap rich rewards for structural-reform efforts so that outside investors can consider LDC bonds and equities with confidence in a long-run perspective.
But Argentina’s President Cristina Kirchner’s populism and indecisiveness in dealing with her country’s debt hangover is a very poor business card from this point of view.
Continued sluggish growth and low interest rates in the West mean that a second chance is emerging for many developing countries. Most LDCs missed the first opportunity: they welcomed Western investments, but they also considered that such inflows reduced the urgency for reforms.
This time could be different, because serious investors will come with a view to promoting new entrepreneurship and will want them to be able to operate accordingly.
Publication Date:
Mon, 2014-07-14 15:17
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