ISQ - January 2022
Key Takeaways
Most emerging markets underperformed most developed markets during 2021, despite typically trading at a valuation discount.
Emerging market investment offers a number of opportunities and challenges for the 2020s
The People’s Bank of China looks set to cut its interest rates in 2022, in notable contrast to the average developed market central banks.
This was a challenging year for the whole world, but judging by the full year equity market losses in Latin America, China, and (outside of India, the UAE and Saudi Arabia) many other emerging market indices, even recovering global economic growth numbers did not provide assistance. By contrast equity markets in the United States, the United Kingdom and Europe produced good gains. Little wonder that global emerging market indices – with nearly half the index focused on China – fell to a relative low against the sector diversified S&P 500 Index not seen since late 2002.
Underperformance can happen for many reasons, not all of which are immediately obvious. The largest four emerging market economies of China, Taiwan, South Korea, and India collectively account for just over three-quarters of global emerging market indices. Economic growth numbers in these names have collectively remained strong, with the economies in both China and Taiwan generating a positive GDP number for full year 2020, despite the COVID-19 challenges. And whilst populations are aging in all economies around the world, the scope for rising consumer expenditure and technological application have been notable drivers over recent years.
Of course any economic evolution take time. And that is especially true in China with its all-powerful Chinese Communist Party. Whilst the country’s former leader Deng Xiaoping once noted that “to get rich is glorious,” the last 18 months has seen the country’s current leader Xi Jinping focused on the rise of the importance of ‘common prosperity,’ which has caused crack-downs on many important consumer, technology, and property sector companies in a manner materially different from forcing extra competition via breaking up dominant companies, as seen in a number of sectors in the developed world over the last century. No wonder stock markets in China and Hong Kong were negative performers across full year 2021.
Growing emerging market economic power is an inevitable part of the 2020s
However, growing emerging market economic power is an inevitable part of the 2020s. The initial rise – and further rise – of the consumer economy has been a dominant part of developed market growth over the past 30 years, as reflected by personal debt levels across countries in North America and Europe. From a trade perspective, there is a reason why the American president has spoken to the Chinese president three times over the last year. Whilst plenty of potential strategic challenges could be apparent during the 2020s, there is already too much in current trade flows to ever stop the leaders talking.
Emerging markets fundamentally have two opportunities and two choices. Beyond the rise of consumer spending, all emerging markets retain a material internal development opportunity.
Whilst every country in the world can see day-to-day life positively evolved by better education, healthcare, and business efficiency, the scope for positive change and impacts is most proportionately apparent in the emerging market nations. This has always been the case, as shown by the material improvements of the South Korean and Taiwanese economies over the last 50 years, countries which today should probably be regarded as developed economy nations. Sadly, in some other countries elsewhere, a combination of politics, wars, crime, and corruption has been negatively impacted. Fortunately the rise of knowledge and awareness is improving.
As for the choices, it is much more than the ‘Belt and Road’ expenditure by the developing Chinese economy to a range of its emerging market peers across the world. The majority of large or mid-cap developed market companies will observe significant opportunities to grow their sales and profitability driven by rising populations and wealth levels in the emerging markets. The smartest choice for all emerging market countries is to encourage local entrepreneurs to find their own products and solutions. Slowly this is occurring more, reflected by the evolving research monitoring lists of global analysts and fund managers.
This is often seen by an acknowledgement that the emerging market world is always broader than many consider. This is not only because of the material economic progress of countries such as Taiwan and South Korea since the 1970s, but also the differentiation between formally defined ‘emerging markets’ and ‘frontier markets’ which are too small, risky, or illiquid to be generally classified as an emerging market economy, covering many countries in the Americas, Central/Eastern Europe, Africa, the Middle East and Asia such as Argentina, Bulgaria, Nigeria and Vietnam. There are reasons why frontier markets have the scope to outperform even their formal emerging market peers during the rest of the 2020s.
The second choice is focused on the environment, which was discussed by around 200 different countries in Glasgow, during last year’s COP26 conference. Environmental matters – if ignored – may have a bigger impact on emerging market nations than any others. Many of the solutions however are global. Whilst many leading emerging markets feel that any environmental changes may take longer than in the developed world, it is also noteworthy to see the importance of the emerging market nations in the production of key clean energy metals such as copper, nickel, cobalt, and the rare earth metals. The anticipated COP27 conference in Egypt in November this year may well see growing awareness of the essential role of the emerging markets.
During 2021 only a handful of developed market central banks – including the Bank of England very modestly in December – raised their interest rates. By contrast nearly 35 emerging market central banks collectively over 110 times during last year, raised their interest rates, reflecting concerns about inflationary realities and the need to maintain positive real interest rates. And whilst both the American Federal Reserve as well as (again) the Bank of England look set to raise interest rates on more than one occasion during 2022, the People’s Bank of China is far more likely to continue its recent interest rate reduction. Overall this is a range of noteworthy differences in a global equity market where the average developed market multiple is at a near two decade high against emerging market equivalents.
Geopolitical risks are always heightened in the world’s emerging markets, but all countries have their opportunities and their challenges. Attempting to work out what is correctly factored in and what is not is always a key investment decision insight.
Issued by Raymond James Investment Services Limited (Raymond James). The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance is not a reliable indicator of future results. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down. The taxation associated with a security depends on the individual’s personal circumstances and may be subject to change.
The information contained in this document is for general consideration only and any opinion or forecast reflects the judgment of the Research Department of Raymond James & Associates, Inc. as at the date of issue and is subject to change without notice. You should not take, or refrain from taking, action based on its content and no part of this document should be relied upon or construed as any form of advice or personal recommendation. The research and analysis in this document have been procured, and may have been acted upon, by Raymond James and connected companies for their own purposes, and the results are being made available to you on this understanding. Neither Raymond James nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon such research and analysis.
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