Global Emerging Markets Outlook 2019
Portfolio Managers Divya Mathur and Kim Catechis share their thoughts on Emerging Markets for the coming year.
7 December 2018
What’s on your radar for 2019?
In the coming year, we’re expecting investors to reconnect with the ‘real world’ growth opportunities in emerging markets (EM). Most recently, we’ve noticed quite a significant dislocation between market reactions and the actual long-term drivers of growth in the asset class. However, as active, fundamental, research-driven investors, we’re excited by the number of high-quality companies where we see tangible long-term growth in earnings and returns.
We are also expecting to see an endgame of sorts materialising on a variety of top-down factors that can shape investment returns – such as the winding down of the US-China trade war and the impact of new multilateral trade deals, mostly involving EM countries, which will serve to underpin economic growth for the decade to come.
We’re excited by the number of high-quality companies where we see tangible long-term growth in earnings and returns.
In this environment, we will continue to focus on several exciting investment themes in EM, such as technology, domestic consumption, penetration of financial services and a changing energy mix; these are all substantially driven by the secular growth of urbanisation, the increasing size of the middle-income group in society and a boost in intra-EM trade – provided by the new trade deals such as the Regional Comprehensive Economic Partnership (RCEP) and the Trans-Pacific Partnership (TPP).
What are the risks in 2019?
Historically speaking, risk for EM has always involved the sudden removal of an external stimulus, like the evaporation of demand from the US consumer, or the sudden shutdown of financing from the developed capital markets (as was the case in 2008). This time round, though, the EM asset class is largely running without external stimuli, which means it’s trajectory is less likely to be derailed by exogenous forces. We therefore view external risks just now as conditional rather than absolute, and for 2019 these will centre on the ongoing trade war between the US and China; the upwards trajectory of US interest rates; and the resultant strength of the US dollar.
The EM asset class is largely running without external stimuli, which means it’s trajectory is less likely to be derailed by exogenous forces.
Our view on these issues is as follows:
Trade war: While there is some way still to go before trade tensions between the US and China properly begin to thaw, a de-escalation between the two nations is entirely probable. We envisage that China will not buckle and the US eventually winds back its tariffs, claiming some face-saving ‘victory’.
US interest rates: the combined impact of an unprecedented corporate tax cut, the oil price run and the inflationary impact of higher import tariffs is likely to keep inflationary pressures on, without the increase in consumer spending power that would come from higher wages.
The US dollar strength that we have seen, would seem to be set to reverse, as investors consider the deteriorating outlook for the US economy over the next 12–18 months. Meanwhile, except for a few outliers, EM sovereigns are now generally very under leveraged, have more debt denominated in local currency and no currency pegs to defend – significantly lessening the importance of dollar strength on EM economies.
What is the market missing?
For me, many investors still seem to be stuck in an old-world mindset with regards to emerging markets. The EM index composition has changed radically in recent years, with commodities (once the stalwart sector of the asset class) now accounting for around 17% after their recent rally. Yet when we look at other constituents of the market, 54% of the index is now in technology, communications services and financials; sectors with little or no leverage and generally high return on equity (ROE)*. The companies in these areas tend to grow their earnings in a more stable and predictable way than cyclicals, so we should expect the structural ROE for EM and hence valuation to grow significantly in the next decade.
Optically, emerging market equities are around their long-term price-to-earnings average. However, we believe the asset class still represents good value in terms of an international equity allocation. Return on equity is fairly synchronised with developed markets, as represented by the MSCI World index. Importantly though, price-to-book and price-to-equity values remain low relative to history and developed markets*.
There is still a real underappreciation of the quality of EM companies. The asset class is extremely diverse and represents a huge opportunity set for investors.
Valuations aside, I think there is still also a real underappreciation of the quality of EM companies. The EM asset class is extremely diverse and represents a huge opportunity set for investors with its best-in-class companies indeed being world class, regularly appearing in leading positions in global surveys of the most valuable brands, the most profitable and the fastest-growing companies.
*Source: Martin Currie and MSCI, as at 31 October 2018.
The opinions contained in this document are those of the named manager(s). They may not necessarily represent the
views of other Martin Currie managers, strategies or funds.
The Outlook for 2019
Our portfolio managers look at what 2019 has in store for investors, the Good, the Bad and the Surprising.