Opportunities will emerge from economic chaos
Developing countries have suffered a huge setback, but opportunities will emerge from the economic chaos
The International Monetary Fund (IMF) didn’t mince its words in June when it said economic activity in emerging markets has decelerated at its quickest pace in 50 years. A direct result of the Covid-19 pandemic, economic slowdown isn’t only occurring in emerging markets – but it’s felt at a much larger scale in these countries because they don’t always have as many financial stimulus levers to pull, and they’re typically more vulnerable to what’s happening in global markets (think plunging oil prices, for example).
Before the pandemic, emerging markets had built a solid case for investment. Some of the world’s biggest and fastest growing companies have their base in emerging markets, including Alibaba (China) and Samsung (Korea). The 25 to 30 countries considered to be an emerging market (a country that’s transitioning to a high-income base) were contributing 74% of global growth and were expected to increase this up to 84% by 2023, according to fund manager Fidelity International. The Fidelity Global Emerging Markets Fund won Money’s 2020 Best International Emerging Markets Fund (see table on p62).
Post pandemic there’s potential for these growth numbers to return; but it’s a widely held view that this storyline will be lengthy. It’s because some emerging markets headed into 2020 with high debt and limited
capacity to help their health sectors or offer financial stimulus to citizens and businesses. The IMF says emerging markets (EM) on average have responded to the coronavirus with financial stimulus totalling 2.8% of GDP, while in advanced economies this figure is 8.6%. It means the road back to “normal” for emerging markets is likely to be long.
Michael Cirami, co-director of global income at fund manager Eaton Vance, says the EM countries that manage to implement stimulus successfully are a good chance of being the winners.
“Three months into the pandemic, it became clearer which EM countries are rising to the challenge and which are not. For example, the bungled responses of Brazil and Ecuador have damaged their leadership role in the eyes of EM investors, while countries like Vietnam, South Korea and Thailand are likely to gain from their effective, transparent policies,” says Cirami.
He says investors in China will likely pause if they judge – as Eaton Vance does – that the country’s transparency in fighting Covid-19 has been less than ideal.
“The pandemic represents the first EM crisis in which many countries have tried to cut rates as stimulus – previously, such moves typically provoked investors to flee the local currency. That has been Brazil’s experience this time as well, as the real slumped as much as 30% against the US dollar,” he says.
“It’s too early to handicap the winners … but not too soon to note that one of the laggards has been India, which has been hindered by inefficiencies in transmitting policy to its 28 states.”
Cirami says during this historic recovery, the research capability required to identify potential winners and losers has never been more crucial.
Picking a winner
What hasn’t changed about emerging markets is that you can get exposure to some of the top companies in these countries by purchasing shares through your stockbroker or online trading platform, provided they have the capability to handle international trades. For broader emerging markets exposure and portfolio diversification, however, an investment in a managed fund (including exchange traded funds) is worth considering.
BNP Paribas Asset Management (the investment arm of the first major foreign bank to operate in Australia) posted on its blog in late June that now could be the time to buy into emerging markets.
It says that, for the past decade, emerging markets have underperformed developed markets, but there are signs the tide is turning. And there’s a widely held view that emerging markets outperform and underperform over 10-year cycles, with the last underperformance wave beginning in 2010.
The investment manager says, in the short term, commoditysensitive Latin America and regions such as Europe, the Middle East and Africa (EMEA) should outperform as crude oil and metal prices continue to recover.
“Equity markets in China may lag due to US electionrelated political tensions,” says Daniel Morris, senior investment strategist at BNP Paribas Asset Management.
Over the medium term, however, he says the effects of China’s attempts to boost its economy should feed through to the rest of Asia, in particular Chinese technology companies.
Morris says IT company multiples (the prices investors are prepared to pay per dollar of earnings) in emerging markets are at some of the lowest levels since the tech bubble in the late 1990s. It means there could be opportunities to grab a bargain.
“On a price-to-next-twelve-month (NTM) earnings basis, relative multiples are similarly near levels not often seen since 2005, after which there was an extended period of EM outperformance,” he says.
Cautious view
In early July, BlackRock, the largest fund manager in the world, made several tactical calls about how it would manage some of its investment portfolios over the next six to 12 months. Most notably it moved to a neutral position on US shares, meaning it doesn’t see any major increase or decrease in these stocks for the next six to 12 months. The $US7 trillion ($10 trillion) manager also moved to an overweight position in European equities.
“The [European] region is exposed to a cyclical upside as the economy restarts, against a backdrop of solid public health measures and a galvanising policy response,” says BlackRock.
When it came to emerging markets, however, BlackRock moved to an underweight position. This means it will typically hold less EM shares than the underlying benchmark indexes for its managed funds.
“We are concerned about the pandemic’s spread and see less room or willingness for policy measures to cushion the impact in many – but not all – countries,” says BlackRock.
In late June, fund manager Robeco produced its thirdquarter outlook for 2020 and it too was taking a cautious view of emerging markets. It matches with the consensus that government finances across the world will look horrible after Covid-19. And those countries with the most leeway to help their population financially will do much better. It says emerging markets like India, South Africa and Mexico are all suffering, even in the upturn seen more broadly across developed markets.
Robeco also looked into the impact that a second wave of infections could have. It says even with partial lockdowns, a second wave would set the recovery back
by at least 12 months. It is also worried about company and country debt levels globally.
“The bad news is that governments would again have to come up with unprecedented stimulus packages and stretch debt dynamics further,” it says, and “many emerging market countries clearly will have less ability for continued support. Caution at country level is therefore warranted here.”
The Robeco Emerging Conservative Equity Fund placed third in Money’s 2020 Best International Emerging Markets Funds.
BNP Paribas Asset Management’s Morris says ahead of the US presidential election in November, it is reasonable to expect heightened anti-China and anti-trade rhetoric from President Donald Trump.
“During the worst of the trade war, emerging markets and particularly China underperformed the US,” says Morris. “That said, the political calculation could also support at least another interim resolution as a rising stockmarket could still be one of Trump’s strongest claims to re-election.”
He adds that weaker currencies will be of less benefit to exporters too when global trade is likely to remain subdued and many developed countries may wish to re-shore production of goods.
Fixed-income manager Brandywine Global released a research note in June that aligned with other perspectives when it came to the actions of governments determining how economies will recover after Covid-19. But Patrick Bradley, senior vice-president of investment research, says, “We have to wonder whether or not governments will come under pressure from citizens straining under the lockdown who have lost jobs and have found it increasingly difficult to feed their families.”
“Many parts of the world have been under mandated lockdowns and the services sector has been especially hard hit, like restaurants and tourism.
“Only essential services have been permitted to operate. This has led to protests across the globe … tensions are rising.
“In most developed countries, the strength of their institutions will allow a peaceful resolution to the lockdown dissents. However, the same peaceful resolution of conflict in emerging markets may be different, where the strength and stability of institutions and government responses to the virus crisis might prevent a resolution of protests or civil disorder.
“Aggressive policies, particularly in EMs, could contribute to social unrest and growing protests, which could exert a negative impact on a country’s economy.”