As we wade through the fallout from the credit crisis, it is easy for investors to be fearful instead of seeing long-term opportunities.
Collectively, the emerging markets had declined more than 60% as of Oct. 29, from an all-time peak about a year ago, though the genesis of the crisis had no connection to the fundamental state of emerging economies.
To date, not a single emerging-markets bank has declared bankruptcy. The Washington-based International Monetary Fund's projection for 2009 gross domestic product growth in emerging markets remains above 5%, while growth projections in most developed economies teeter near zero.
Although certainly not immune to an economic downturn in the developed world, emerging-markets companies and countries are in far better shape to weather this storm than at any time in their long and somewhat volatile history.
We have past crises to thank for that. Previous high-profile crises such as the Mexican peso crisis of 1994, the so-called Asian contagion of 1997 and the Russian debt default of 1998, while painful to live through, were economically and politically cleansing, and made emerging economies more investible.
The implementation of much-needed structural reforms required for sustainable economic development in a number of markets was one key outcome.
And many economic policymakers, chastened by the crises of the 1990s, have continued to maintain sound economic policies in recent years despite a prolonged period of "easy" money in the United States and in other major economies.
We have seen improved corporate governance, more highly developed commercial and legal structures, and responsible fiscal and monetary policies. Markets such as Brazil and Mexico are attracting a more dependable stream of foreign investment.
Inflation, an unhealthy characteristic of past emerging-markets crises, generally has declined during the past two decades — in some cases sharply.
The more recent history of many emerging markets has been one of strength and stabilization. National wealth in those markets, as measured by foreign-exchange reserves, has risen rapidly in recent years, providing a critical financial cushion to help absorb economic shocks.
As a sign of prudent macroeconomic management and foreign-investor confidence in emerging markets, the foreign-exchange reserves of emerging-markets countries are exceedingly healthy.
Economic growth in a number of the emerging markets continues to be exceptionally strong, relative to many developed nations. The increased wealth in these countries has resulted in an improvement in local consumer spending, which in turn helps make growth in these countries more sustainable and somewhat more independent of the developed world.
Given that 85% of the world's people live in developing countries, their expanding wealth is a powerful potential driver of growth.
Robust economic growth also has led to increased investment in infrastructure development, such as roads and bridges, while boosting the ability of many emerging-markets companies to export raw materials and consumer goods to meet global demand.
Many of these companies have become more profitable, enabling businesses to reduce debt, strengthen their balance sheets and generate growing levels of free cash flow. A combination of less debt and more cash typically paves the way for capital investments, higher dividends and profit growth.
Given the high rates of investment and GDP growth, it should come as no surprise that emerging markets have also produced above-average returns, versus developed nations, for many investors willing to assume the risks of investing in these markets.
But amid the broader market sell-off, investors have punished all investments indiscriminately, regardless of their fundamental underpinnings.
We can take comfort in knowing that we have seen similar turnarounds in the past. Investors who stayed committed during volatile periods often have come out in better shape than when they went in.
Although the valuation gap between emerging and developed economies is shrinking, the pullback presents a compelling opportunity to add this rapidly growing asset class at a discount. For those investors with long-term investment horizons and the capacity to assume the risks associated with these markets, rarely has the big picture been more attractive.
Daniel Graña is a portfolio manager of the Putnam Emerging Markets Equity Fund, from Putnam Investments of Boston.
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