Has the view on emerging economies become excessively bearish?

A slower roll-out of vaccines hampered emerging markets’ recovery from the pandemic, but the region now looks set to catch up.

A slower Covid-19 vaccine roll-out and the use of cheaper, less effective jabs may have hindered emerging market (EM) sentiment, but with conditions improving and most of the bad news priced in, investors should now look beyond the pandemic to the plethora of diverse opportunities across the region, according to experts at T. Rowe Price.

Emerging markets, particularly China and other Asian countries, were applauded for their swift action dealing with the coronavirus outbreak last year. Having been first into the crisis they were also first out, and stock markets reflected just how effective they had been in controlling the virus through rigorous lockdowns and restrictions when compared to developed markets such as Europe.

However, the tide turned following the announcement of approved vaccines in November 2020.

Daniel Hurley, Emerging Markets Portfolio Specialist at T. Rowe Price, said emerging markets fell behind as developed countries ‘were successfully rolling out vaccinations at a much quicker pace’ at the same time as the Delta variant began to spread rapidly through EM.

Affordability has been a key reason why the roll-out has been slower. In addition, there has been more widespread use of the Sinovac Chinese vaccination in emerging markets, which data has shown to be less effective compared to the mRNA vaccinations such as Pfizer, Moderna, and AstraZeneca that have been used more widely in developed markets.

More recently, however, vaccine rollouts have picked up pace and increased use of the mRNA vaccinations means Dan does not see the region being left behind for long. With much of the bad news priced in, he thinks it could now be prudent to look past the pandemic to the long-term opportunities.

The area is benefiting from the ‘massive stimulus we’ve seen in the US, Europe, and the UK over the past 18 months’ which has triggered soaring demand for products from developed world consumers who find themselves with more cash to spend.

‘Emerging markets are the exporters of the world, which is partly why we think that recovery is going to come through so strongly,’ he said. ‘Semiconductors is an area where demand has risen substantially, for example, and the vast majority of those semiconductors are produced in South Korea and Taiwan.’

One area the firm’s investment team has been ‘very much bullish’ on over the past year is commodities, with the firm’s EM value managers moving overweight energy for the first time at the height of the pandemic in 2020 when oil was down to US$40 a barrel.

‘However, with oil back at around US$70, we’ve actually reduced that commodity exposure in May this year after a strong run,’ Dan confirms.

Instead, the team is now focusing its attention on ‘unloved’ financials.

‘We can find some good quality banks with ROEs (return on equity) of over 20% and dividend yields of up to 8-9%,’ he said. ‘These are very attractive levels and banks can benefit from higher oil prices and a strong commodity cycle.’

Dan still believes in China and said recent stock market turmoil over government regulation of education providers and anti-trust concerns is just the latest stage in an ongoing cycle of reforms.

‘China actually grew in 2020 and it is in a position where it can tighten monetary and regulatory policy in 2021,’ he said. ‘We have seen before that the government tends to try to push through regulatory reforms when they’re in a strong economic position to do that.’

According to Dan, current fundamentals reflect too much bad news. The discipline of many EM central banks through the pandemic, he explained, means they have the economic foundations in place to come back stronger.

‘Central banks in EM have not spent as much as developed markets, and we’ve seen countries like Brazil already starting to hike interest rates to keep inflation muted which should enable them to recover quickly from the near-term headwinds,’ he said. ‘At a broad level, valuations are also cheap relative to US markets, and especially European markets right now.’

Market sentiment may have wavered in recent months but there is still a plethora of reasons to invest in emerging markets, not least ‘financially disciplined’ companies and a meaningful pick up in vaccine roll-out aiding countries’ recoveries. Importantly, earnings, which have been under significant pressure since early last year, appear to be recovering ‘We think the current bearish sentiment is excessive and provides an attractive entry point to invest in selected areas of emerging markets where the longer-term investment case remains robust,’ he said.

Emerging markets are less established than developed markets and therefore involve higher risks.

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The specific securities identified and described are for informational purposes only and do not represent recommendations.


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