With emerging markets, like China, Taiwan, and South Korea, being some of the world’s fastest advancing economies, these markets are increasingly seen as the place for retail investors to be. North Asia soared in the third quarter of 2020 on the back of strong investor interest in technology and innovation.
While developed markets have seen more substantial second or third waves of the pandemic, a number of emerging markets have been relatively effective at managing the pandemic. Over October, the MSCI Emerging Markets Index gained 2.06%, while the MSCI World Index dropped -3.07%. China has proved the most resilient and reported 4.9% year-on-year Q3 2020 GDP growth, showing that it is bouncing back more strongly than the rest of the world from the covid-19 pandemic.
Emerging market sectors to watch
Technology and innovation: Emerging markets have evolved away from commodities and are now heavily weighted in technology, giving exposure to leading-edge innovation which is, in turn, reshaping the industrial landscape across emerging markets.
The covid-19 pandemic has also reinforced key structural trends of increased institutional resilience, growth of consumption, technology, innovation, and the ability of companies to “leapfrog” developed-world competitors.
Emerging markets are consequently expected to be driven by e-commerce, internet services, artificial intelligence, robotics, high performance computing, and cloud computing, with household names like Samsung, TSMC, Tencent, and e-commerce giants Alibaba delivering significant growth.
The political consequences of the Biden election cannot be ignored. A review of US policy towards China would be welcomed by markets. There could potentially be new trade accords at the end of next year or into early 2022. But the current US administration could implement additional measures against China which may be difficult politically to unwind, bringing short term volatility to markets.
The Chinese consumer opportunity is still one of the most attractive, exciting opportunities for investors. To a large extent, Chinese consumers have already emerged from the pandemic and there is already a very large middle class looking to spend their money on better things, better experiences, better products, and better services. This appetite has created a premiumisation opportunity in the heart of the consumption story.
South Korea also presents an opportunity for investors with a number of very exciting companies, leveraging growth online as well as in technology hardware (e.g. semiconductors). We see structural growth in these areas, supported by attractive valuations at companies such as Samsung.
In addition, if we look at the Korean balance sheets at a sovereign level, Korea is one of the least leveraged major countries globally, with Government debt to GDP less than 45%, compared to nearly 100% in the UK. Korea is also a net oil importer, thus benefiting from the decline in prices, alongside the majority of emerging markets.
While the Indian economy was in a cyclical low as the pandemic struck and it instigated a pretty severe lock down, economic indicators are now showing signs of recovery, while the younger demographics are beneficial due to a lower susceptibility to covid-19.
The large population provides huge opportunity from both a consumer penetration and premiumisation perspective, as the growing middle class has an appetite for higher end products and services. All this means that long term opportunities should remain intact.
A Biden administration may not necessarily be positive for global energy prices – any green policies in the US would reduce demand, while deal-making with OPEC to manage supply may be less likely, which could impact Brazil.
However, Brazil has had a lot thrown at it in the last two to three decades and remained resilient. The country is not seeing a second wave of virus cases (perhaps due to having avoided an initial lock down, and allowing the first wave to spread) and so is well place for recovery over the next six to 12 months. Structurally declining interest rates are encouraging a shift in consumer savings to equities from fixed income, which is a boom for the financial sector.
Russia is one of the least leveraged countries globally with Government debt to GDP lower even that South Korea. Households are also typically under leveraged. There is an inherent resilience to Russia that people underestimate and there are far more common interests between the US and Russia than people realise. Where the Biden administration takes its relationships with Russia will be key. The country has some excellent businesses in the energy, technology and financial sectors and improving corporate governance has been an important driver of share prices.
Impact of covid-19 and vaccines on markets
Key emerging markets, including China, Taiwan, and Korea, have been highly effective in managing the crisis with health outcomes drastically superior to the West. With the virus under control, this has enabled a broadening of economic recovery and earnings visibility, giving markets confidence. A vaccine would accelerate this across a wider swathe of emerging economies and accordingly the recent breakthroughs with Covid-19 vaccines are highly welcome.
TEMIT has been conservative in its expectations of the recovery: the assumptions were that it won’t be until the 4th quarter of 2021 that there would be a return to more normality across most of these economies. There should however be much more economic activity earlier next year driven by the roll out of the vaccines and the increased adaptability to and effectiveness in handling COVID.
China has, in particular, handled the pandemic response well, given the country’s vast size and population. The pandemic has sharpened the divide between China and the rest of the world in many aspects. Over the longer term, COVID-19 should be a bump in the road for China’s long-term growth, given it has been rebounding quickly from it.
US election result could be positive for EMs
With a Biden presidency, we should expect a softer policy stance towards China; there should be reduced trade uncertainty, and less disruptive foreign policy. Biden himself is very much seen as an establishment globalist, which means that his election could signal a potential US return to the Paris Accord, to the Transpacific Partnership and possibly even the Obama Iranian deal.
Overall, emerging markets have been extremely resilient to the macro environment and continue to present significant opportunities. There is a continued valuation gap between developed market equities and emerging market equities, and the asset class continues to evolve, moving away from commodities and towards technology. Economic growth across most emerging markets is expected to recover and well exceed pre-covid-19 levels with earnings projected to outstrip the US. The IMF growth expectations for emerging markets and developing economies currently stands at 5.9% compared to 4.8% for the US.
Finally, there are the multiple catalysts outlined previously that will drive the performance of emerging market stocks through 2021.
Chetan Sehgal is lead portfolio manager of Franklin Templeton’s TEMIT.