Finding value in developing markets
- Emerging markets have seen a significant economic hit from the pandemic
- Many emerging markets are recovering quickly from the economic weakness, particularly corporate earnings
- Reform is still a major driver for growth across emerging markets
Covid-19 has hit emerging markets every bit as hard as it has hit developed markets. While many have younger populations and therefore lower mortality rates, this has been offset by underdeveloped healthcare systems and constrained government finances. However, as the world starts to recover, emerging markets may have some natural advantages.
Like their developed market peers, emerging markets have seen economic damage from the pandemic. The figures, in many cases, make for uncomfortable reading. India, for example, saw its economy contract 23.9% from March to June. For Latin America, it was a similar picture. Peter Taylor, senior investment director on the Aberdeen Latin American Income fund, says: “We have seen shocking numbers in terms of economic contraction, reflecting the global economic slump that we’ve experienced across both developed and emerging markets.”
However, in many areas, there are clear signs of recovery. This is particularly true for Asia, where China’s rapid emergence from the virus has helped its economy revive, along with those of its neighbours. Gabriel Sacks, investment director on the Aberdeen Standard Asia Focus trust says: “There is an expectation that there will be a very sharp rebound for earnings going into 2021. There is likely to be around a 5% drop overall this year, followed by a 25% bounce next year.”
That said, the recovery is not just confined to those areas that have successfully managed the virus. In Brazil, one of the hardest-hit regions from the crisis, earnings are being revised higher. Taylor says: “The speed at which the Brazilian economy normalised gives us cause for optimism. Consumption, for example, rebounded faster than expected and we have seen this feed through into the earnings for consumer companies, which are being revised higher.”
In general, emerging markets have not taken on the same government borrowing as developed markets. Many have not had deep enough pockets, or the same unfettered access to international debt markets. This has limited their ability to spend. This may be a disadvantage in the short-term, but is potentially an advantage in the longer term as their economies aren’t weighed low by debt and they do not face the same cliff-edge drop as stimulus is withdrawn.
Emerging market companies also tend to be less indebted. Sacks says: “Companies are typically very disciplined when it comes to managing their balance sheets and capital allocation. Net debt to equity is a lot lower in Asia than it is developed markets.”
There are other considerations that should favour emerging markets. Reform is still a major driver in many economies. In India, for example, we see continued reform to tackle corruption, promote financial inclusion and digitalisation. Kristy Fong, senior investment director at Aberdeen New India investment trust, says: “The government’s commitment to reform has been very consistent. This is the government’s second term and they have put through very difficult reform measures, which will be great for India in the long-term.”
In Brazil too, there has been a continuation of the reform agenda under Jair Bolsonaro in spite of the disruptive impact of the pandemic. A number of reforms are currently under review in Congress, including a public sector reform bill to lower payroll costs and improve efficiencies; there are also plans to reform the complex and inefficient taxation system.
The US election may also prove to be a game changer for some emerging markets. Firstly, a more stable and predictable approach to foreign policy should be better for everyone. While it is unlikely that President Elect Biden will fundamentally shift the US’s stance on China, he is likely to take a more measured approach.
Elsewhere, the advantages will be more apparent. Biden has a history of good relations with Latin America. Equally, the region may be a beneficiary of greater fiscal stimulus in the US, though the size may depend on whether Biden secures control of the senate following the election in Georgia in early January.
Sacks says: “We expect a Biden win to be good for emerging markets. A blue wave, where the Democrats won the Senate and Congress would probably have been better, but our expectation is that monetary policy and fiscal policy should remain loose, which should result in a weak dollar.” Taylor adds: “The most important thing is the end of uncertainty about the outcome. This creates a certain degree of visibility going forward.”
Emerging markets also have more compelling valuations. While emerging markets have outpaced their developed market peers since the market turned in April, they had a long way to go to catch up. Over 10 years the MSCI Emerging Markets has delivered annual growth of just 2.4%, compared to 8.6% for the MSCI World. Equally, many of the early gains have come from China, which has left other emerging markets some way behind. There is significant scope to catch up.
That said, while this suggests a favourable backdrop for emerging markets, investors need to be active and to focus on quality. In this type of environment, the strong will get stronger. Fong says: “One of the opportunities we’ve seen is that in challenging times, strong companies get stronger as the weaker ones find it harder to survive.”
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