How Emerging Markets are transforming global trade
Emerging markets (EM) are transforming global trade patterns. Against a backdrop of growing protectionist policy measures in many developed economies, EM countries are, by contrast, actively cultivating and developing their trade partnerships.
27 February 2018
For example, as the chart below illustrates, compared with twenty years ago when the majority of international trade took place between advanced economies, most international trade is now between advanced and emerging economies. Importantly, though, it is exports between emerging economies that has increased the most. We believe this intra-regional EM trade, in particular, will shape international trade flows in the decades to come.
Shifting the axis of world trade
Several factors have recently shifted the gravitational axis of world trade in EM’s favour. The US withdrawal from the Trans-Pacific Partnership (TPP) earlier this year has largely been viewed as a geopolitical and economic boon for China as it creates space for it to fill the void in trade in east Asia. And although it was initially feared that the TPP would dissolve without US involvement, an 11-strong membership is looking to keep the deal alive. This should liberalise commerce across several EM nations including Chile, Peru and Malaysia, and – if agreed – would be one of the world’s most significant multilateral trade deals.
The US departure from TPP has also meant that the China-backed, 16-nation Regional Comprehensive Economic Partnership (RCEP) has now gained far greater relevance. The RCEP includes both China and India and represents a quarter of the world’s GDP. The pact also comprises Japan and Australia, but notably does not include the US.
And while renegotiations regarding the North America Free-Trade Agreement could be damaging to Mexico, a number of bilateral trade deals are strengthening ties between emerging market countries. In particular, China has for some time being pursing trade links with many South and Central American countries, signalling greater diplomatic and economic activity between the regions outside the sphere of influence of developed markets.
The growing importance of intra-regional trade
More and more, EM countries’ most important import and export partners are other developing nations. China, for example, is by far the top export destination for Brazilian products. While South Africa, India and Russia import more goods from China than any other country. This intra-regional trade is only set to continue with trade blocs, such as the ASEAN Free Trade Area (which includes Thailand, Vietnam, Indonesia, Malaysia, Philippines, Singapore, Myanmar, Cambodia, and Laos) generating considerable internal trade momentum outside trading links with developed markets. As the chart below demonstrates, the vast majority of import values for the ASEAN region come from its own members as well as China.
The New Silk Road
China’s New Silk Road, or ‘One Belt One Road’ (OBOR) initiative is an audacious project that will have major benefits for increasing the ease of trade from China, across Asia and beyond. It is estimated that US$2–4 trillion of capital will be spent across 68 countries to build infrastructure in the form of ports, airports, highways, railways, power generation plants and pipelines. With this kind of transformational improvement in transportation links, it’s easy to imagine the potential benefits that will open up for the EM countries and companies whose markets will expand as a result.
Emerging countries are also becoming increasingly significant in terms of international trade as they become wealthier and domestic demand rises. The rapid pace of growth in many EM markets is driven by a raft of strong secular trends: improving demographics provide a young and increasingly well-educated, growing workforce; while on the other side of the equation, a rising middle class, specifically in urban areas, will continue to propel strong consumption growth across many markets.
Take the global auto sector for instance. China is already the world’s biggest vehicle market – 2016 saw 28 million new registrations, which was more than the US, Canada and Mexico combined. However, when you also consider China’s appetite in the burgeoning electric vehicles market (a rise of 381% between 2014–2016 in newly registered EVs in China*), it’s clear that EM will play a major role globally as both recipient and producer in such markets.
Growth of the supply side
As demand and consumption rises in EM, a confluence of supply side reforms, efficiency improvements and innovation has also paved the way for greater export capabilities. In particular, many EM companies have begun to lead the field in areas such as internet technology and e-commerce. Chinese names like e-commerce giant Alibaba and Tencent have built huge footprints domestically (note that in China, US tech giants like Facebook, Amazon and Google are peripheral players in their respective areas of social media, e-commerce and search engines). Meanwhile, other EM tech firms, like colossus chip-maker Taiwan Semiconductor, are central players in global supply chains – providing components for major brands like Apple.†
Emerging market advantage
Emerging markets now play a more significant part in international trade than at any other point in history. Strong secular growth trends in EM have spurred a monumental supply-side response through innovation, reforms and improved capacity utilisation. At the same time, recent shifts in developed-world trade policy towards a more protectionist stance, have contrasted with the more broadly free-trade outlook of EM countries. This, we believe, puts many EM companies at a distinct advantage to their developed market counterparts and will continue to drive EM growth for many years to come.
Emerging markets still represent good value
But does all this growth potential come at an elevated price? We would argue that it currently doesn’t, and that the asset class still represents good value in terms of an international equity allocation, despite the large inflows into EM over the past year. As illustrated in the charts below, it is clear that return on equity (RoE) is bottoming and now ahead of developed markets (as represented by the MSCI World index). Importantly though, price-to-book values remain low relative to history and developed markets. As such, we believe the time is ripe for a reappraisal of the long-term opportunities that emerging markets present and we remain convinced that an active approach is the best way to reap the rewards.
* Source: Statista. Statista source: International Energy Agency
† Please be aware that the information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the securities discussed here were, or will prove to be, profitable.
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