Franklin Templeton's Mark Mobius remains positive on emerging markets performance

SA and Russia disappoint in quarter two, while the larger frontiers look interesting                                   

The second quarter of 2007 had most emerging markets recording strong performances, as evidenced by Morgan Stanley Capital International indices, showing an average of 15% return in US dollar terms. Taking a longer term view, these markets offer investors an attractive investment destination as they continue to report strong macroeconomic growth and implement structural reforms.

The Latin American markets were the top performers for this second quarter as the region continued to experience net fund inflows and major regional currencies strengthened against the US dollar. In dollar terms, for the second quarter, Brazil returned 24%, Chile 21% and Peru 34%.

Brazil's first quarter GDP grew 4,3% year-on-year (y-o-y) driven mainly by growth in private consumption, fixed capital investment and exports. The central bank continued to implement a loosening monetary policy, cutting the key interest rate by 75 basis points to 12,0% and government maintained its inflation target for 2007 at 4,5%. International credit rating agencies upgraded Brazil's sovereign rating to BB+, one level below investment grade, as a result of the country's strong macroeconomic fundamentals, improved current and trade accounts and growing foreign reserves.

In contrast, GDP growth in Mexico decelerated to 2,6% in the first three months of 2007 from 4,3% in the last quarter of 2006. The main culprits were slowing consumer demand from its key trading partner, the US, and a fall in construction expenditure. But the market managed a comfortable 13% USD return in the second quarter.
 
In Asia, markets such as China, Thailand, South Korea and India (in part due to a strong Rupee) outperformed their emerging market counterparts despite political issues in Thailand and overheating concerns in China and India. In dollar terms, China markets moved up 24% in the second quarter, India 21%, and Korea and Thailand lifting by 18%.

Although China has implemented tightening measures, its continued robust macroeconomic performance has raised expectations for additional actions. First quarter GDP grew 11,1% y-o-y while inflation reached a 27-month high of 3,4% in May. The trade surplus grew 73% y-o-y to US$22,5 billion and in an effort to address international concerns over the countrys ballooning trade surplus, China has cut export-tax rebates on thousands of products effective July 1, 2007. In addition to raising interest rates and banks reserve requirements, China expanded the Qualified Domestic Institutional Investor (QDII) program to allow domestic fund managers and brokerages to invest in foreign securities. This highlights governments continued efforts to curb fund flows into Chinas surging domestic stock markets.

South Korea reported the economy growing 4,0% in the first three months of the year. Household debt growth slowed in the same period as growth in new mortgages and credit card purchases eased and inflationary pressures remained low.

Key European markets such as the Czech Republic (Q2 up 13% in USD) and Hungary (up 29%) recorded robust performances, while Poland (14%) and Turkey (16%) also saw their performances further enhanced as a result of a weaker US dollar. Despite the political uncertainty, investors remained confident of Turkeys fundamentals where GDP growth accelerated to 6,8% y-o-y in the first three months of 2007 from 6,1% for last year as a whole. Government expenditure and export growth were key drivers.

Russian markets, however, continued to underperform (Q2 flat at 0,53% in USD) as negative media exposure, the failure of the Russia-European Union summit and greater friction with the US led investors to stay on the sidelines. Economic growth remained healthy with first quarter GDP increasing 7,9% y-o-y, marginally higher than the 7,8% in the last three months of 2006. The construction sector was the fastest growing, recording a 23,2% growth during the first three months of the year.

South Africa also lagged behind its peers, ending the second quarter with a minor gain in the markets of 2,71% in USD and -0,13% in Rand terms. The SA economy grew 5,4% y-o-y in the first quarter, slower than the 6,2% in the last three months of 2006 as interest rate hikes in the later part of 2006 filtered though the economy. In general, domestic demand remained robust in the first three months of 2007 and government expenditure surging 14,0%, nearly triple the 4,8% increase seen in the preceding quarter. The central bank recently raised its benchmark rate by 50 basis points to 9,5% due to rising inflationary pressures. Inflation accelerated to 6,4% in May, breaching the Banks 3%-6% target range.

The role of emerging markets in the global economy has grown significantly in recent years. These countries have made fundamental improvements to their economies and these changes are here to stay.

In addition to the traditional emerging markets, the larger frontier markets such as Slovenia, Romania, Ukraine and Dubai are also beginning to look interesting.

In general, the strong fundamental outlook for emerging markets remains intact. Investors should expect volatility, as is the nature of these markets, but long-term investors can expect to be well rewarded.