Despite much stronger fundamentals, emerging market share prices have experienced a sharp selloff, with the MSCI Emerging Markets index falling by nearly 40% since 19 May. For a long-term investor, this creates very attractive buying opportunities.

Emerging markets have become one of the casualties of the US banking and housing crisis even though their exposure to the financial turmoil seems very limited. The sharp fall in equity prices is due to the following factors:

• massive liquidation of emerging market positions by foreign investors because of a sharp rise in risk aversion. According to a research note by Morgan Stanley, foreign selling since mid-2007 amounts to some 60% of the inflows to these markets in the 2003-07 bull market;
  
• fears of a broad-based global economic downturn;
  
• higher inflation in the region;
  
• fears of a sharp fall in earnings of emerging market companies;
  
• a sharp decline in commodity prices which has weighed on markets like Brazil and Russia;
  
• geopolitical issues with the Russia/Georgia war and political instability in Thailand.

The notion of emerging markets is very vague in many investors' minds. They usually think of the "BRIC" countries, Brazil, Russia, India and China. It is therefore important to stress that when I talk about emerging markets, I am mainly referring to South-East Asia and, to a lesser degree, Mexico and Brazil (even though some of these countries might justifiably be offended by being called 'developing' or 'emerging'). These countries' economies are being driven by the following developments:

• young populations and increasing labor productivity;
  
• increased economic and financial maturity following the 1997 crisis;
  
• much improved macroeconomic variables in the form of fiscal and current account surpluses, a rise in international reserves and a drop in foreign indebtedness. This greatly reduces these countries' dependence on foreign capital and gives them much more flexibility in terms of currency and monetary policy decisions, which in turn leads to reduced economic volatility;
  
• a generally healthy banking system;
  
• much improved inflation dynamics;
  
• the emergence of local institutional investors (such as sovereign wealth funds and pension funds);
  
• improved corporate governance and profitability following the crisis of 10 years ago;
  
• low household and corporate leverage.

To summarize, 10 years ago the impact of the emerging world's poor economic fundamentals spread to the developed world eventually prompting a financial crisis. At the time, the United States had the strongest fundamentals and recovered fastest. Today, we have to a certain degree the mirror image of 1997/8 with poor US fundamentals (making the crisis much more severe) and strong fundamentals in the emerging markets.

Ultimately, the litmus test for emerging markets will be whether or not their economic growth can continue in an environment of low or no growth in the industrialised world. The jury is still out but the above graph, courtesy of BCA Research (http://www.bcaresearch.com/) is encouraging. It shows that in the past, whenever there was an economic slowdown in the G7 countries (using the G7 leading indicators as a proxy), growth in the emerging world suffered (using emerging markets industrial production as a proxy) as it relied to a large degree on exports to the West. The current economic slowdown in the G7 countries has however not (yet?) translated into major economic weakness in the emerging world.

I think that even though a major recession in the US would obviously have a negative impact, the secular themes of rising consumption and infrastructure investment will continue to support economic growth in the developing world. The banking crisis in the West will accelerate the relative rise of the developing world. The centre of gravity for the world economy continues to shift east and equity returns should reflect this shift in the long run. The indiscriminate selling of emerging market equities since May thus gives investors an opportunity to invest at attractive valuations. Based on trailing 12 months earnings, emerging markets have rarely been as cheap in the past 20 years.