Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 422

Four reasons emerging markets should outperform post-COVID

Policymakers in both developed and emerging markets are attempting to reopen their economies as they manage the virus , with varying degrees of success. Despite the short-term uncertainty, there are plenty of attractive opportunities for investors in emerging markets.

1. Inflation is transitory amid central bank discipline

Inflation in emerging markets is often misunderstood. About 85% of the MSCI Emerging Markets Index is made up of six countries: Brazil, Russia, India, China, Korea and Taiwan. Add South Africa and Mexico and almost the entire index is concentrated in a relatively small number of countries.

Supply chain dislocation and numerous bottlenecks due to COVID-19 have caused a big pop in inflation both in emerging and developed markets. We anticipate this will be transitory as disruptions diminish and headline inflation begins to reduce, allowing lower monetary policy rates to be sustained.

Most importantly, it’s been vital for emerging market countries to maintain the hard-fought credibility of their central banks. So far, the signs are good. As an example, at present there’s a night-and-day difference in the improved quality of central bank management in Brazil compared with what we saw in 1991.

2. Emerging markets are maturing

The pandemic has shown that the emerging market complex is looking more mature, with Brazil and Russia hiking interest rates to maintain credibility. This is a stark shift from 2020, where central banks across the world were forced to cut rates in order to protect economies following the onset of the virus. While developed markets remain mired in emergency level policy settings, it is pleasing to see the emerging world pivot to a more proactive stance.

In fiscal stimulus terms, there haven’t been substantial moves outside of those countries with large international reserves or the ability to borrow capital on the international market. The emerging markets approach has been cautious and supportive. For example, China has been very restrained relative to what it did in 2008, while still providing ample stimulus to return its economy to a strong growth footing. Ironically, because emerging market countries couldn’t borrow as much as the West, there’s a lot less pressure placed upon their currencies and debt levels than in developed countries.

Overall, it looks like the emerging market complex will get through this period of unprecedented monetary and fiscal policy response while actually strengthening the credibility that has been built up over the last 20 years.

3. Emerging markets currencies and commodities are attractive

Emerging markets currency (EMFX) is reaching levels we haven’t seen since 2002. From 2001 to 2008, there was a very substantial rally in EMFX. One of the great convergence trades was when China, India, Brazil, Korea and Taiwan emerged on the global scene. Their GDP developed well, resulting in a dramatic rerating of emerging markets.

Since the bounce after the GFC, these countries have performed poorly relative to the S&P500. But that is set to change as emerging market countries benefit from surging demand for commodities on the back of significant global stimulus, infrastructure spending and recovery.

We’re more bullish on commodities than most, but the street is catching up with our numbers. The outlook is positive for lithium (due to short-term demand and a lack of supply), copper (it is integral to decarbonisation and electric vehicles) and aluminium (thanks to supply base issues and the need to ‘greenify’ production). We’re less bullish on steel and we’re very bearish on iron ore relative to the consensus due to significant supply capacity in Australia and Brazil.

Commodities remain important for the emerging market complex in supporting economic growth. Therefore, we believe emerging markets countries will provide strong outperformance over the next couple of years, if not the next decade, versus the developed markets. As a result, EMFX now looks very attractively valued.

4. Chinese regulatory risk is manageable

The recent China Securities Regulatory Commission (CSRC) meeting with executives of major investment banks attempted to ease market fears about Beijing’s crackdown on the private education industry.

The regulator made clear that China will continue to welcome foreign capital and that there is no intention of any economic decoupling. The authorities will allow time for policy adjustments and public consultation. Unsurprisingly, the CSRC also outlined a positive economic growth outlook for the country.

We believe this gives reassurance that the tutoring industry decision was a unique case. If China can convince the market that the regulatory changes are not an attack on profitable companies, confidence should slowly return.

The last 30 years of investing in China has shown that you don’t want to be fighting against the authorities. The key point about managing Chinese regulatory risk is that if you align yourself with the authorities, there are very substantial returns to be made.

Which emerging markets sectors could outperform?

The pace of COVID-19 vaccine rollout is accelerating in larger emerging market countries, which is helping their cyclical recoveries. This trend is expected to continue throughout the second half of the year and may allow emerging markets to reopen their economies faster than expected, resulting in significant GDP growth throughout 2021.

As an asset class, MSCI emerging and frontier market equities are expected to be up 7-12% in the next 6-9 months (source: RWC Partners and Bloomberg as at 30 July 2021). This will see the so-called ‘Fragile Four’ – Brazil, India, Turkey, and South Africa – outperform, while long-term upward pressure on the price of oil will also see Russia and Saudi Arabia benefit. China will continue to be weighed down by geopolitical forces and the lack of flows into emerging markets.

Thematically, we expect everything climate change-related to do well, including copper, lithium, solar energy, alternative energy, and electric vehicles. The EMFX carry trade remains intact which should support the financial services and housing sectors, especially in high yielding countries. In emerging markets, the COVID-19 recovery will be fuelled by travel, modern retail, and consumer discretionary spending.

 

James Johnstone, Co-Head of Emerging & Frontier Markets at RWC Partners, a Channel Capital partner. Access to the RWC Global Emerging Markets Fund is available to Australian investors via Channel Capital, a sponsor of Firstlinks. This article is genral information and does not consider the circumstances of any investor.

For more articles and papers from Channel Capital and partners, click here.

The webinar “RWC Partners: Adapting to the future – long term trends in emerging and frontier markets” can be viewed here.

 

RELATED ARTICLES

What to watch in post-pandemic 2021

Brazil on the eve of the World Cup

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

Policy proposals allow young people to access their super for a home bought from older people who put the money back into super. It helps some first buyers into a home earlier but it may push up prices.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.