From 1958 to 1968 and again from 1975 to 1994, Brazil suffered from high and even hyper-inflation. In only 12 of the last 65 years has inflation been below 10 per cent, and seven of those years have come in the last eight years. It is this change from high to low inflation that has allowed the Brazilian market to return 16 per cent a year since 1995: twice the return from each year of US equities over the same period. Inflation increases inequality, impoverishing the majority of the population. It also undermines If that assumption is correct then, except for individual countries such as Venezuela, the inflation risk in emerging markets is low and on a completely different scale to that experienced in the period from 1970 to 2000. Therefore the two strategic risks that need to be understood and monitored are political upheaval (which leads to the appropriation of assets via revolution as in Russia, China, Turkey, Egypt, Chile, Cuba, Iran, Algeria and Vietnam, among others), and inflation (which destroys the real value of assets, as seen in Argentina, Brazil, Zimbabwe, Russia and Indonesia). Political risk need not be as dramatic as some of the revolutionary examples given, but may involve an undermining of the rule of law and a pervasive culture of bureaucratic and corporate corruption that siphons wealth from shareholder to domestic powerbrokers. As such, monitoring of political risk should be broadened to governance in general rather than just revolution.
Tactical issues Alongside the two strategic risks are the two tactical issues that should inform any equity investment, emerging or developed: earnings and valuation. Over the last 10 years, emerging market debt has re-rated, reflecting a dramatic improvement in credit quality as the asset class approaches investment grade. Equities, in contrast, trade at levels similar to those of a decade ago, meaning emerging market equities currently appear cheap against emerging market debt. On an earnings and asset basis, emerging market equities also appear to be trading close to longterm averages. The great difference between bonds and equities is that the former trade on perceptions of solvency, the latter on perceptions of future profitability. Valuation is therefore not a concern on a tactical basis as long as market expectations for earnings and dividend growth are not unrealistic. Following the cyclical collapse of 2008, earnings have grown very strongly, with the market returning over 20 per cent in 2010.
