While world stocks have risen more than 5 percent already this year, stock markets in China and Brazil are flat to negative in dollar terms. Seems like EM’s golden era has passed. But why exactly?

Reuters’ Sujata Rao explains:

“Godet’s calculations show a steep decline in return-on-equity (ROE) in emerging markets to around 12 percent, a fall of 3 percentage points in the last 18 months and well below pre-crisis levels of 16-17 percent.

That lags developed markets’ 13.5 percent. But U.S. firms – “the ultimate quality and growth markets” in Godet’s words – have usurped EMs’ ROE supremacy with a 15 percent average. ROE shows how well a company is using shareholders’ equity investment to generate profits.

“The deterioration has been both fast and large,” he said.

“If you look at any of the criteria associated with profitability, you see that between 2011-2012 emerging markets were unable to transform economic growth into earnings growth.”

The ROE slump is a bad omen and inflows have started to stutter.

ING Investment Management for instance recently downgraded emerging markets holdings in its equity portfolio.

Flat corporate earnings in emerging markets last year despite revenue growth of around 12 percent.

Developed companies meanwhile have stayed profitable through years of economic doldrums, posting single-digit revenue growth in 2012 but managing a 2-3 percent rise in profits, he adds.

“Longer-term expectations of higher growth and demographics (in emerging markets) are valid, but what we have seen in the past couple of years is disappointment, because compared to developed markets, companies have been … less able to protect their margins,” Davis said.

“After the crisis, U.S. and other developed market companies really tried to improve efficiency by investing less, deleveraging balance sheets, accumulating cash and conducting optimization of their operations,” Godet said.

“EM companies continued to invest as if the crisis of 2008 hadn’t happened, as if growth was just as strong as before.”

Those buying emerging stocks after 2008 joined the party too late, they say, predicting in a note that the sector is only 27 months into what may be a multi-year period of underperformance.”

Source: Reuters

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