Emerging Market Equity Valuations Are Close to 20-Year Lows…So Is It Time to Buy?
By Alastair Reynolds, Portfolio Manager, Global Emerging Markets at Martin Currie
The Coronavirus pandemic has brought challenges to emerging markets but the EMs of today are very different from those of five years ago.
Q: How did emerging markets (EMs) weather the global financial crisis? Are they doing the same things during today’s pandemic?
A: At first sight, EM countries do not appear well placed to deal with the twin challenges of global economic recession and COVID-19. Yet the EMs of today are different from the EMs of five years ago – and dramatically so from those of the global financial crisis in 2008-2009.
Emerging markets have undergone significant structural change over recent years, helping build economic resilience, while reducing dependence on the developed-world business cycle.
Many factors contribute to this economic robustness, including strengthening domestic consumption trends, reduced reliance on commodities, stronger balance of payments profiles and more stable inflation. These themes are here to stay, rendering backward-looking analyses of EM less useful when thinking about the opportunities of tomorrow.
Q: With EM equity valuations close to 20-year lows, is now the time for investors to buy?
A: Many EM portfolios are operationally benefiting from the challenging environment, particularly those focused on the technology, communication services and health care sectors.
We continue to have confidence in long-term growth drivers in key thematic areas including:
- Sustainable planet,
- Cloud-based data,
- Financial inclusion, and
- Digital disruption.
Q: How have currency moves, inflation and employment impacted EMs in recent years?
A: Not only have EM economies jettisoned currency pegs, but many have improved their current account positions and built up foreign exchange reserve buffers. This translates into less economic sensitivity to the waxing and waning of capital flows.
A significant improvement in EM inflation trends has also contributed, putting EMs on a path of convergence with developed market (DM) rates. This has been widely attributed to more credible monetary policy management by EM central banks (the adoption of inflation targeting), as well as reduced currency volatility driven by a broad-based improvement in macro fundamentals. This has taken place against a significant drop in EM unemployment pre-pandemic.
Q: How challenging are the economic and social conditions EMs face due to the pandemic?
A: The pandemic has brought challenges to all of the global economies, not only those in emerging markets. The extent to which markets will be impacted varies from country to country.
Take, for example, the larger Asian economies. The likes of China, South Korea and Taiwan have managed to contain the spread of the virus with less economic disruption than has been the case in the U.S. or Europe. Their economies are expected to show a return to growth earlier than elsewhere in the world.
These economies are also net importers of oil and gas so they will actually benefit from the recent fall in oil prices. Alongside lower transportation, there has been a surge in on-line consumption, remote working and digital communication. This plays to Asia’s strengths given its technology heavy stock markets.
Elsewhere in EM, there are bigger challenges, with the virus still spreading at a high rate in Brazil, India and Russia. This places regional and federal governments in these nations under a lot of strain, just as it has in the U.S. and European markets. Whilst Russia has a strong sovereign financing position to deal with temporary pressure, the financing situation in Brazil and India is less resilient.
Q: What other investment themes do you favor in this volatile market?
A: Urbanization is resulting in higher incomes, rising consumption levels and higher levels of physical investment. This is being helped by trends such as the creation of megacities. There are more than 30 megacities in the emerging countries – each with a population of 10 million plus – and they tend to have even higher consumption patterns than other large cities in the country.
A great example of urbanization and demographic change being structural drivers for a portfolio is an Indian consumer paint company.
This is a classic example of a demographics beneficiary in an economy with a low per capita consumption of paint and a growing number of households, aided by governmental policies to build more affordable housing and encourage wider home ownership. As incomes rise, consumers also trade up to more expensive premium paints.
Q: How is technology impacting EM economies?
A: Technology is changing the way consumers behave and interact, creating both opportunities and challenges for EM businesses. It’s particularly pleasing that EM countries now have leadership in technological innovation and their consumers are adopting the changes first.
We continue to invest in tech franchises that inspire confidence in their long-term sustainable growth prospects and have strong balance sheets, allowing them to withstand prolonged weakness.
Alastair Reynolds is a Portfolio Manager of Global Emerging Markets at Martin Currie, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.
Alastair Reynolds, Portfolio Manager of Global Emerging Markets, Martin Currie
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