Time to return to emerging markets

Shopping in China © Alamy
China’s consumption will reach today’s eurozone levels by 2030

Emerging markets have been reinvigorated this year. The benchmark MSCI Emerging Markets index has returned 9.3% in 2019 and has reached a six-and-a-half-month peak. Developing-world currencies have also risen against a weaker dollar. And the rally looks set to endure now that “the stars have aligned” for emerging-market equities, says Udith Sikand in a Gavekal research note.

One reason for optimism is the US Federal Reserve’s decision to put interest-rate rises on hold. That has removed one of last year’s major headwinds. When interest rates are rising and the dollar is strong, money tends to flow out of traditionally risky assets, such as emerging markets, and into US securities with rising yields.

A boost from China

In addition to the Fed riding to the rescue, there is hope that there will soon be a trade deal between the US and China. An agreement to end tariff increases “and possibly reduce or scrap existing tariffs will largely eliminate” one of the key risks that rattled emerging-market investors last year. Another reason for optimism is Beijing’s effort to stabilise China’s economy. That should “put a floor under many emerging economies”.

Some of the bigger emerging-market economies are looking a bit more energetic in any case. Brazil, for example, is gradually recovering from its 2015-2016 recession. Meanwhile, Russia’s GDP grew by 1.5% year-on-year in the third quarter of 2018. That’s despite the fact that analysts at Bloomberg Economics estimate sanctions have knocked 6% off Russia’s economy over the past five years. This year the country’s currency, the rouble, has been “a stand-out emerging-market performer”, says Aaron Saldanha on Reuters. It went up by 8.6%, helped by a 26% rise in oil prices since the start of 2019.

Valuations also point to plenty of further upside. The MSCI Emerging Markets index has a forward price/earnings (p/e) ratio of 12 and “looks cheap compared to its own history”, Charles Shriver of T Rowe Price Global told MarketWatch. For now, however, the recovery may be limited to Asia, reckons Sikand. “Most of the upside will be experienced by Chinese equities and by markets closely within China’s economic orbit.” This includes South Korea and Taiwan. The effect of stimulus on China’s construction sector is “likely to be muted”, which means that its impact on commodity-driven Latin American markets will be muted too.

The growing middle class

Keep the compelling long-term overall outlook for the asset class in mind, however. Young populations and rising standards of living are boosting demand for “luxury goods, such as electronics and cars”.

According to the Economist Intelligence Unit, China’s middle class (those with more than $10,000 of annual disposable income) will rise from 132 million in 2016 to 480 million by 2030, making up over a third of its population. This will raise the country’s consumer spending to current eurozone levels.