Much of the shine has come off one of the dominant investor stories of the past two decades: emerging markets. Globalisation has gone into reverse, growth in goods trade never recovered after the financial crisis and, more recently, developed country politicians have been raising tariffs to try to keep jobs at home. The flow of manufacturing jobs from rich countries to poorer ones, and goods back the other way, has slowed. Which emerging markets can investors still get excited about?
The two biggest, China and India, look less appealing than they once did. Growth in China has been slowing for some time and the spread of a new strain of coronavirus has hit economic activity further, on top of the already struggling property sector. India’s economy is in the doldrums. The prospect of business-friendly reforms now looks remote under Prime Minister Narendra Modi.
In fact, according to the IMF, reform efforts have dwindled right across the developing world. A wave of financial liberalisation, privatisation and opening to multilateral trade in the 1990s helped unleash the rapid growth of emerging markets in the 2000s, the fund argues, but now governments face the much trickier task of deregulating labour markets and improving governance generally. Reforms have been slowest in the poorest countries.
But there are still plenty of reasons for investors to consider the opportunities within emerging markets. In particular, financial conditions are supportive. Since the US Federal Reserve has given up on “normalising” interest rates, monetary policy appears to be in a “goldilocks” spot — neither loose enough to encourage destabilising hot money flows, nor tight enough to cause problems for states that rely on external dollar funding. Low inflation will help many poorer countries.
For investors with cash to deploy, developed markets face macroeconomic headwinds too. Manufacturing across the US and Europe is in trouble, partly on the back of trade tensions and partly because of the car industry’s specific troubles, including overcapacity and the fallout from the diesel emissions scandal. This has meant slowing growth in Europe, the US and developed Asia, all of which have also been affected by the slowdown in China too.
Emerging market valuations are lower than in developed counterparts. The S&P 500, the main US index, is only slightly off its record and is trading at a price-to-earnings ratio of 22 compared with its average over the past five years of 20. Emerging markets may have lost some of their appeal, but that means canny investors can look for value in underrated areas.
A differentiated approach is needed. Now that the peak of globalisation has passed, a rising tide may no longer lift all boats. Instead, emerging market investors need to look for the less obvious and the undervalued: countries with a specific story about why they, in particular, will do well out of the new world order. Many may be recovering from periods of turmoil and still have elevated levels of risk.
Ukraine, for example, is doing well, partly thanks to ambitious reforms and disciplined fiscal policy. Emerging Europe generally, including Bulgaria and Serbia, may benefit from European companies looking to bring supply chains closer to home. Mexico, too, can serve the same purpose for American companies as the global economy fragments — although in the short term there are troubles at the state-owned oil company. Many analysts flag Egypt, which completed an IMF programme last year, as a potential outperformer. Globalisation may have peaked, but there are still opportunities out there.
