It has been a rough few months in emerging markets. In July, China reported its slowest growth in 27 years after its manufacturing sector faltered amid trade tensions with the US. Meanwhile, Argentina appeared on the cusp of another crisis as reformist Prime Minister Mauricio Macri was defeated in recent primary elections. These events have been reflected in financial markets, which have lurched lower in the second quarter.
Emerging markets can’t seem to get back on their feet. After a long period when they were derailed by twin currency crises in Turkey and Argentina, they defied the weakness in developed markets at the end of 2018. However, they now appear to be struggling once again. With clear signs of weakness in the global economy, can they revive?
Certainly, emerging markets face some headwinds. The trade tensions are a problem, not just for China, but for all those that rely on China. The reliance of other Asian markets on China has increased in recent years as intra-regional trade has expanded.
Stefanie Mollin-Elliott, fundamental analyst at Unigestion, says the path ahead for emerging market equities will depend on the outcome of the trade conflict and the global economic growth outlook. She believes there is a chance of both a higher equity risk premium being placed on emerging market equities, plus earnings growth headwinds for companies in the region: “Emerging markets tend to suffer in a risk-off market environment and we would expect growth outside the US to continue to be weak, with emerging markets underperforming until trade headwinds dissipate.”
Peso Problems
For her, the recent Argentine peso depreciation and decline in the Argentine stock market following the surprisingly negative results of the primaries has been a harsh reminder to investors of the elevated emerging market political and economic risks.
Mollin-Elliott is concerned about data out of China, where macro figures are decelerating on multiple fronts. Total social financing disappointed the market with growth decelerating from June. Credit demand, meanwhile, has weakened and is unlikely to pick up again until stimulus gets ramped up further possibly through infrastructure spending and the housing market. Slowing economic growth in China has negative consequences for much of emerging markets, which relies on the powerhouse as an export market for their products.
However, amid this gloomy prognosis she believes there may be beneficiaries: “In a scenario of slowing global growth from China slowdown and/or US-China tariffs, a safe place to hide in emerging markets may be in those market which are benefiting from China’s tariff pains such as Taiwan and South East Asia." Countries that can offer resilient earnings growth and are not at the core of the trade dispute should also outperform, such as India, Indonesia and Thailand. It may be worth adding Vietnam to that list, with the country picking up some of the manufacturing that is leaving China.
Richard Harding, head of Asian equity research at research at Waverton Investment Management, also highlights this area as one of potential growth He says South East Asian (Asean) countries have shown previously that they can outperform both Asia ex Japan as well as wider global emerging markets in periods when there are concerns about global growth.
He explains: "This is perfectly logical given the makeup of their economies and their stock markets. Over the medium to long-term – and with or without the trade war - manufacturers will continue to diversify outside of China to Asean's advantage.”
Positive Signs
Andrew Morgan, portfolio manager at Walker Crips, is more positive. His view is that events in China and Argentina cannot be broadened into an "emerging markets problem", and that the fundamental picture across many emerging markets is still reasonably good. Investors may then do better to consider each emerging market individual rather than as a single entity.
He adds: “The direct effects of Argentinian turmoil are likely to be tiny: Argentina is a closed economy which, along with its banking system, is probably too small to cause ripple effects by itself."
Morgan says thinks the biggest risk is not Argentina's direct economic links to other countries such as Brazil, its largest trading partner, but the implications for managing a portfolio: "If a shock in one area of the market like Argentina necessitates a reduction in risk, portfolio managers may be forced to raise cash from other higher-risk areas of the market, causing a downward spiral effect.”
However, Morgan points out that emerging markets have been given a reprieve by the change in sentiment by the Federal Reserve, which recently cut interest rates after raising them four times last year. Emerging market central banks now have some breathing space to cut rates and boost growth. As a result, Morgan believes emerging markets are more attractive than they were a year ago.
Emerging markets are likely to be dented by weak sentiment in the short-term. However, over the longer-term, the economic picture for emerging markets is still reasonably strong. The sector is not homogenous and there are always opportunities, even if individual markets struggle.
