The gains emerging-markets investors enjoyed earlier in 2019 have moderated as simmering trade tensions between the United States and China have flared and subsided. Yet, even against that backdrop, the picture remains favorable.
“The long-term story is that emerging markets are a very good place to be,” says Chris Heakes, director, portfolio manager, exchange-traded funds, at BMO Global Asset Management in Toronto. “They have the highest [gross domestic product] growth rates, high population growth and there’s a lot of room to run in banking, technology and resources.”
Yet, emerging markets have under performed their developed market counterparts thus far in 2019. The MSCI Emerging Markets Index, which is a good measure of the performance of the growth economies in Asia, the Far East and Latin America, was up by 3.90 per cent for the year-to-date as of Aug. 31. The index, which includes large- and mid-cap stocks in 24 countries, has more than 1,100 constituents. In comparison, the S&P/TSX Composite Index was up by 14.80 per cent and the S&P 500 index rose by 16.74 per cent during the same period.
“It’s going to be a muddle through sort of year,” says Christine Tan, portfolio manager at Sun Life Global Investments Inc. (SLGI) in Toronto. Tan specializes in emerging markets and was former chief investment officer at Excel Funds Management Inc. before SLGI acquired that firm in 2017. “On the negative side, you have trade discussions and you won’t see a full or partial deal until the end of the year. So, we have another five or six months of this. The offset is very dovish central banks. Of course, a big tailwind to the upside would be a trade deal [between the U.S. and China].”
Tensions between the world’s two largest economies have hurt trade flows and caused uncertainty, particularly for manufacturers, which are delaying capital investments until the shape of a trade deal becomes more apparent. Neither the U.S. or China has enough leverage to impose its will, so the relationship may well be one of managed struggle and intermittent crisis.
On the plus side, the trade war has been counterbalanced, to some extent, by lower interest rates globally. Stock markets rose once the U.S. Federal Reserve Board and other central banks became dovish and began cutting interest rates. Ms. Tan sees emerging markets with more room to cut domestic interest rates.
“You have already seen that in South Korea and India,” she says. “The Reserve Bank of India has cut [interest rates] three times this year and is expected to cut again. Brazil has room to cut.”
Another plus for emerging markets is the changes made to central banks’ policies and tighter financial market regulation following the global financial crisis in 2008, which left emerging-market economies able to withstand currency and trade shocks better.
Although each emerging market has its own economic driver, Ms. Tan says that broad structural changes have left emerging markets’ institutions stronger. In addition, corporate debt levels are manageable and more companies are borrowing in local currencies, which means they’re less affected by the strong U.S. dollar.
Nevertheless, the U.S.-China trade war is the biggest factor affecting emerging markets, and Ms. Tan says the dispute will mean a reworking of the global manufacturing supply chain, with benefits and drawbacks.
“There will be disruption,” she says. “Things will get more expensive, in certain cases, because [companies] may not be manufacturing where the cost is lowest. It may be closer to home, but the offset there may be cheaper transportation.”
Still, Mr. Heakes says investors should look past the current headlines.
Emerging economies have contributed more than 80 per cent of global growth since the global financial crisis. The World Bank’s June 2019 Global Economic Prospects report foresees emerging markets growing by an average of 4 per cent in 2019.
China, India and Indonesia are expected to fare much better, with India growing at 7.5 per cent, China at 6.2 per cent and Indonesia, 5.2 per cent. That compares with the Conference Board of Canada’s 1.4 per cent growth forecast for Canada in 2019.
Sustained, strong growth is the reason why the Canada Pension Plan Investment Board (CPPIB) plans to have up to one-third of the Canada Pension Plan’s assets invested in emerging markets by 2025. Mark Machin, the CPPIB’s president and chief executive, stated in the organization’s 2019 annual report that it’s committed to “pushing deep” into emerging markets.
Mr. Machin noted that the areas of focus for the CPPIB are China, India and Latin America. Already, emerging markets accounted for 19.9 per cent, or $77.9-billion, of the CPPIB’s total net investments as of March 31, the organization’s annual report reveals.
India, one of the key areas of focus for the CPPIB, is at the forefront of the growing global middle class and undergoing a rapid industrialization, Mr. Heakes says. “So, it’s a good story and continues to be.”
Meanwhile, he adds that “China is having a pretty good year with equities up by 10 per cent. … That spills over into the rest of Asia.”
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(This article appeared in the Globe & Mail Globe Advisor section of the Report on Business Sept. 10 2019.)