Emerging markets have been a tough place to invest for over a decade, particularly outside China. Today, there seem to be even more reasons to worry.
- Emerging markets look set to outpace developed markets, but only marginally – 4.8% versus 3.9% for 2022.
- Emerging economies are still bearing the brunt of Covid with low vaccination rates and creaking health infrastructure
- However, they are cheap and the tide may be turning on interest rate policy
It is very difficult to make the case for emerging markets today. Rising US rates, sluggish growth and rising geopolitical tensions have seldom been a good backdrop for the asset class and there is little to suggest this time will be different. Do emerging markets have anything going for them today?
The strongest argument in favour of emerging markets has been growth. Yes, there was higher risk, but it was worth taking that risk to access faster growth in a low growth global economy. Rising wealth was creating a burgeoning middle class, which in turn was drive consumption. It was a virtuous circle and created a fertile environment for companies to grow profitability.
The latest IMF World Outlook shows how much that has changed. While emerging markets still look set to outpace developed markets, it isn’t by much – 4.8% versus 3.9% for 2022. And in reality, much of that growth is coming from emerging and developing Asia, particularly India, rather than anywhere else. Brazil, for example, is set to grow an anaemic 0.3% in 2022, Mexico just 2.8%. Is it worth taking the risk for a growth rate lower than Japan?
It is emerging economies that are still bearing the brunt of Covid. Vaccination rates are low in many areas, while health infrastructure has been tested to its limits. Some economies have built up significant debts dealing with the pandemic. Many have been forced into rapid interest rate rises to deal with inflation. The final nail in the coffin for emerging markets is rising rates in the US. This typically pushes the Dollar higher, which will raise borrowing costs for some emerging markets.
So far, so gloomy. Is there anything to recommend emerging markets? They are diverse. It is tempting to see them as an homogenous unit, but their fortunes may prove very different. The Ukraine crisis, for example, may help commodity-rich countries. China is easing monetary policy, which may boost its economy and that of its major trading partners. With many countries already well advanced in the rate rising cycle, it is plausible that some will have slayed the inflation demon and be cutting rates long before the cycle turns in developed markets.
The other element is that emerging markets look very cheap. Over the past year, the average global emerging market fund is down 9.2%. That compares to a rise of 14.9% for the average UK Equity Income fund. In reality, emerging markets have been weak for a decade even if some fund managers – mostly those focused on Chinese Internet stocks – have managed to eek out a good return.
As seasoned investors recognise, sometimes the outlook doesn’t have to improve very much for sentiment to change – and in the case of emerging markets, it could hardly get much worse. It’s difficult to make a bull case, but on the other hand investors don’t have much to lose.
