Corporate earnings growth to drive emerging markets

Emerging markets have performed very strongly this year. Chris Palmer, Gartmore's Head of Global Emerging Markets, says the performance case for investing in the asset class in 2010 is fundamentally compelling.

Emerging market returns next year will be dominated by the growth of corporate earnings. Gartmore estimates that earnings will grow by 25% in 2010 compared with price/earnings ratio of 13x as of October 2009. At the same time, the return on equity from emerging market companies is over 40% higher than that of the MSCI World Index.

Gartmore's analysis indicates that the growth outlook has begun to normalise, favouring a return to earnings-oriented investing. The market rally over the past 10 months was characterised by an initial rebound from depressed levels of valuation. However, the next phase will be driven by growing corporate profits. Companies that can finance their growth through their own cash flows will have a key advantage.

This next stage of market development should suit Gartmore's investment style. We aim to invest in companies with sustainable growth and we value a company's ability to generate strong free cash flow.

The really positive news is that we're seeing a recovery and rebounding cash generation across a broad range of sectors and industries. This means we can have a healthy exposure to energy and other cyclical industries that, in some developed markets, are still constrained by relatively tight credit conditions.

We remain vigilant of the US dollar. Countries such as China, Korea and Taiwan are open to dollar-based commodity inflation. However, we expect any rising inflation risk to be contained by an upturn in exports as the US economy recovers. We continue to monitor inflationary pressures.

Domestic consumer trends in emerging markets remain strong. The global economic recovery does nothing to discourage our investing in a broad range of domestic consumer discretionary companies, from automakers to manufacturers of branded consumer durables.

Companies in the developed world could be facing permanent exclusion from emerging markets. During the global downturn, companies in the developed world fell behind in terms of launching new products into emerging markets. Meanwhile, in countries such as Brazil and China, local companies took market share. So, the big surprise in 2010 could be a substantial uptick in M&A, as companies from the developed world attempt to gain entry or make up for lost time.

The outlook for commodities remains good. Credit constraints mean we are not likely to see a return of the profligate speculation we saw in commodity markets in 2007 and 2008. However, since we are only in the early stages of a global recovery, the demand for commodities will remain strong. We are finding plenty of attractive investment opportunities in resource-rich countries, from India through Brazil to Russia.

The Gartmore Emerging Markets Opportunities Fund and Gartmore China Opportunities Fund reflect these positive views, with significantly overweight positions in the materials and consumer discretionary sectors. Conversely, these funds have underweight positions in defensive market areas with lesser growth prospects, such as consumer staples, telecoms and health care.