Emerging Markets  

Rooting out value in emerging market stocks

Rooting out value in emerging market stocks

After rising nearly 40 per cent in US dollar terms in 2017, emerging markets (EM) suffered a setback in the first half of 2018, triggered by investor concerns over rising US interest rates, trade tensions – particularly between the United States and China – and the US dollar strengthening.

However, EMs still offer value for investors. 

Rising trade tensions have prompted a cautious investor outlook, but in our view the market reaction has been excessive. In recent years, intra-EM trade has become more important and rising protectionism could further turn focus towards more regional agreements.

For example, the long-term growth of intra-Asia trade is centred on China as the country transitions to a consumption-based economy, opening up new opportunities for trade in Asia.

We believe trade disruptions would only impact China in the short term and may help speed up China’s efforts to upgrade its economy with additional investment in the service and higher-value added manufacturing sectors.

In our opinion, what has been hurting sentiment is not trade policy itself, but continual trade tensions and uncertainty. We believe businesses can adapt and develop long-term strategies around trade policies once there is greater clarity. 

We aim to look beyond the ‘noise’ of negative news headlines and instead focus on the underlying fundamentals of the EM asset class.

While a few countries such as Argentina and Turkey may have skewed overall investor perceptions, we believe many EM currencies are attractively valued and well-supported after recent downward moves.

Key points

  • Emerging markets suffered a setback in the first half of 2018, on the back of trade tensions and rising US interest rates
  • Negative sentiment on emerging markets is overplayed
  • Emerging market economies have been shifting to ‘new economy’ industries

These countries with strained finances continue to attract the bulk of headlines, but it is worth noting their relatively small size in the context of the broader emerging markets asset class, as well as the extent to which their fundamentals are weaker. For example, Turkey represents only 2 per cent of the MSCI Emerging Markets Index, Pakistan 0.5 per cent and Argentina is not even in the index yet.

We also consider fears regarding US dollar strength to be overblown.

Short-term risk aversion and a slight upward move in the US interest rate trajectory have contributed to the dollar’s climb, but we do not expect these drivers to be sustained over the long term. 

It is important to remember that not all emerging markets will be hurt by the same factors, and individual market performances vary considerably.

As stock pickers, we can choose among the varied opportunities that emerging markets offer to build well-diversified portfolios that seek to avoid excessive risks. 

Drivers for growth

Asia so far has stood out for several reasons: structural growth in the technology sector; rising consumption; and economic reforms in countries such as China and India.

In China, supply-side reforms and deleveraging could help ease structural risks, but rising trade tensions could offset the benefits of stronger global growth. We are also positive on countries such as Taiwan and Thailand, where macroeconomic data remains healthy.