After a decade of trading relatively sideways while the developed markets, especially the United States stock market, went aggressively up, emerging markets stocks seem finally poised to outperform in 2021 and beyond.
The emerging markets region, more specifically in Asia, was the first to face the pandemic and also is the furthest ahead in the economic restart. If we look at China, after the huge economic collapse in the first quarter of 2020, the economy was the first to start seeing growth. In fact, the International Monetary Fund is not expecting any country to show pre-pandemic economic numbers before at least 2022, with China being the only anomaly, thus becoming a leader in the global recovery.
An important aspect for the region is the fact that the new Biden administration in the US is anticipated to conduct a ‘softer’ rhetoric in relation to trade, and hence a more positive continuation of dialogue with China is expected. Coupled with the fact that the two countries’ leaders have climate change as a common goal, we could potentially see improvements in the relationship.
Another interesting trend that emerged from the lockdown and is expected to continue in Asia is the increase in demand for e-commerce and the strong shift towards 5G technology. Asian countries, notably South Korea, China and Hong Kong became the first early adopters of this technology, and with more countries now expected to roll-out, increased capital expenditure for 5G should not only assist in the rebound of economic activity but also provide an additional competitive edge in technology against global peers.
The pandemic has also tested the resilience of Asian banks and could widen the growth gap between digital leaders and laggards in the coming years. This emerged as digitalisation has been the highest priority prior to the pandemic and is expected to remain on the agenda. With lower policy rates likely here to stay until at least 2023, banks have limited levers to pull to raise returns, thus digitalisation should help Asian banks to defend market share and exploit growth opportunism in the global market.
Looking more geographically, it was the smaller markets of southeast Asia that were hardest hit by the pandemic in 2020. This was because of their weaker healthcare infrastructure, greater reliance on tourist activity and limited listed exposure to winners in the online and technology sectors. However, they have bounced back strongly amid the vaccine optimism and have now came back onto investors’ radar.
We should be able to see good earnings growth out of emerging markets
China, of course, remains the go-to country, and although it may have lagged following the vaccine news, it remains by far the broadest and deepest equity market in the region. It offers a much more interesting range of stock opportunities, both in the mainland A-share market and in the Hong Kong and US listed companies. Here, investors can get exposure to the full range of sectors and a steady flow of new initial public offerings that constantly refreshe the options available.
Another important catalyst for emerging countries emanates from the possibility of further weakness in the US dollar. With the US embarking on what might potentially become a long period of policy coordination with their ultra-loose monetary policies and additional fiscal stimulus, it is possible that we will see the dollar heading lower in the months and years ahead. If the dollar heads down (as it has been consistently doing since March), emerging markets should gain.
This happens since for US investors, the value of shares in foreign currencies increases as the dollar weakens, and hence encourages more investment from the US to international markets. A weaker dollar allows emerging market countries more freedom to provide fiscal stimulus without fearing negative implications for their own economies. For instance, an emerging market government might feel more comfortable with fiscal easing if its currency is rising, dampening the potential for an inflationary shock.
Even though both emerging Asian equities and developed markets had a similar rebound in performance since the March 2020 lows, there is a higher potential for over-performance in Asia as equities are currently trading at around 30 per cent discount versus the developed world. Future earnings growth is also expected to be higher due to the fact that Asia is still benefiting from external demand, particularly when growth in developed markets will be propped up by fiscal policy, and in turn support Asia exports.
In addition, emerging markets are a high-beta, that is, more volatile than the stock market as a whole. This has an effect on the global earnings cycle, and with the global cycle now in an early expansion, we should be able to see good earnings growth out of emerging markets.
The writer and the company have obtained the information contained in this article from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this article. They have no obligation to update, modify or amend the article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate.
Christian Buhagiar, portfolio manager, BOV Asset Management Ltd