Q&A: WHAT DOES THE GLOBAL PANDEMIC MEAN FOR EMERGING MARKETS?


By Kim Catechis, Head of Investment Strategy at Martin Currie


Martin Currie has built a proprietary database that helps it analyse the strengths and weaknesses of 70 countries. It covers quantifiable items such as sovereign vulnerabilities and banking supervision as well as contextual items such as demographic and geopolitical issues.

Kim Catechis, Head of Investment Strategy, explains that the firm’s investment outlook is built on quantifiable data but viewed through the lens of contextual inputs.

Catechis answers questions about Martin Currie’s current views on emerging markets.

Q: Which emerging markets (EM) countries will benefit the most from the current situation?

A: Taking into account financial resilience, government and institutional capacity, sensitivity to low oil prices and evidence of healthcare security, the countries that appear best placed to come out of this crisis at a reasonable pace are China, South Korea and Taiwan.

These countries are more advanced in dealing with COVID-19. We can judge their efforts successful; their economies are getting back to normal and they are beneficiaries of low oil prices. Of course, they need clients in the U.S. and EU to get back to work too in order to keep growing.

It is too early to say how Indonesia and India are coping with the pandemic. The most challenged are Mexico, Saudi Arabia and Russia, countries dependent on oil revenues and less obviously coping with COVID-19. Brazil is underperforming in its management of the given its relatively better infrastructure at the start of the pandemic. Perceptions could change rapidly in healthcare security.  

Q: Which sectors are particularly well positioned to recover?

A: E-commerce platforms, well-capitalized banks in countries with low penetration of banking services, and strong brands in the luxury segments will recover strongly in the next three years.

Q: Which EM countries are the most fragile?

A: EM countries do not appear well placed to deal with the twin challenges of global economic recession and COVID-19. This is a function of the heterogeneous nature of the asset class. An historic source of economic dislocation for developing countries, external debt, is estimated at around $7 trillion, roughly equivalent to 225% of EM reserves. However, the dispersion hidden in those numbers is significant and continues to grow.

Turkey’s external debt is around 600% of its foreign exchange (FX) reserves. China’s external debt is around 50% of FX reserves. Turkey accounts for less than 0.5% of the MSCI EM index. China is the largest country constituent, at 36%. The top 10 countries account for 89.2% of the MSCI EM index, which seems a lot, until you consider that the U.S. accounts for 60% of the equivalent MSCI World index, whose constituents are exclusively developed countries.

Q: Will the deteriorating relationship between China and the U.S. have a significant impact on crucial global supply chains?

A: The short answer is yes. Pressure has been building on these supply chains since 2016, when the Trump administration began to apply tariffs targeting China.

The longer answer: Trade, industrial and economic policies based on the “old world” view of value chain optimisation are unlikely to bear fruit. The new policies must consider politics and foreign affairs as well as service capabilities, workforce skills and digital infrastructure.

No matter who is next elected president, it seems probable that U.S. policy towards China will continue to be confrontational – the one thing Republicans and Democrats agree on!

For investors and for companies, this means slower decisions on the deployment of capital expenditures, more investment in political analysis, less flexibility in organising the value chain, and higher return demands from the higher perceived political risk premium. The U.S. has become a less transparent, less reliable country to invest in. European companies will increasingly prioritise intellectual property protection and, at the margins, will diversify geographically away from China, but still try to avoid sacrificing market share there.

Q: How will Asian economies fare, especially those like Taiwan and Korea that are heavily reliant on the electronics cycle?

A: Dependence on electronics is both a key vulnerability and a bullet-proof jacket. For South Korea, the widest definition of electronics – communication and audio-visual equipment as well as memory boards – accounts for roughly 30% of exports. The country’s biggest export markets are China (26%) and the U.S. (12%), according to the World Bank.

For Taiwan, 42% of exports go to China, versus 12% to the U.S. Taiwanese companies have built an extensive manufacturing footprint in mainland China and semi-finished goods and components are exported there, for eventual re-export from China as finished products. Taiwan’s dependence on electronics, integrated circuits and micro assemblies is around 30%.

Q: European markets are full of stocks sensitive to the impact of Coronavirus (autos, banks, energy, capex goods producers, etc.). What should be done to soften the economic impact?

A: The biggest economic impact of the battle against COVID-19 is in European small and medium enterprises, which form the backbone of most economies. The significant stimulus packages on the table are very good and need to be executed well.

There may have to be more stimulus over the next two years. This will leave future generations with a significant burden, but I do not see an alternative. It is better to pay companies to keep workers on the payroll, even at reduced wages, than let unemployment rocket and pay those benefits. The U.S., Germany and France provide testing grounds.

I wonder about the generalised expectation of “more from the EU.” Healthcare was never assigned to the EU – it lies with national governments.

Kim Catechis is the Head of Investment Strategy at Martin Currie, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.

Kim Catechis, Head of Investment Strategy, Martin Currie


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