Emerging markets: Outlook and opportunities

Geoffrey Wong and Projit Chatterjee, our Emerging Markets specialists analyse the current state of EM, highlight attractive investible trends, and explain why the time is now for EM equities.

15 Sep 2020

Key takeaways

  • COVID-19 has delivered a severe economic hit to both Developed and Emerging Markets (EM), but the recovery has been quite sharp, and we are seeing improvements in activity;
  • EM countries and companies entered this downturn with healthy fiscal balances, room to ease policy, sound company balance sheets, and little excess capacity;
  • COVID-19 has accelerated investible trends within EM, such as the shift from offline to online, investment in R&D and innovation, industry consolidation, and supply chain shifts;
  • Long-run trends remain intact, we see opportunities amid changing demographics, growing discretionary spending, increasing R&D and innovation, and widening financial inclusion;
  • Current valuations make for attractive entry points. Active management will be key to capture opportunities amid near-term volatility from COVID-19 and geopolitical tension, as well as over the longer term since EM are under-researched and evolving rapidly.

COVID-19 has delivered a severe economic hit to EM, but the recovery too has been quite sharp.

We are seeing improvements across EM, for example factories in China and Korea are now largely back to work, but we remain below pre-COVID-19 levels in some key sectors.

EM countries and companies entered this downturn with healthy fiscal balances, room to ease policy, sound company balance sheets, and little excess capacity.

Net debt/equity, 1996-2019

Source: Worldscope, Datastream, UBS IB, May 2020

Acceleration amid disruption

For all that COVID-19 has disrupted daily life for millions, it has also accelerated investible trends within EM, with four standing out in particular:

  1. The shift from offline to online: benefiting business segments like after-school tutoring, financial services, and healthcare diagnosis.
  2. Investment in R&D and innovation: driven by growing demand for automated solutions, AI-driven technology, high-quality healthcare, as well as online entertainment and communication services.
  3. Ongoing industry consolidation: many smaller firms are finding it difficult to cope and will likely go out of business. Stronger and larger players are likely to benefit by growing market share.
  4. Supply chain shifts: Even prior to COVID-19, the move to reduce dependence on the China supply chain had started. The pandemic provides additional impetus and favored destinations are South-East Asia and India plus reshoring back to North America, South Korea or Japan.

Long-term themes remain intact

These trends sit on top of a series of long-term investible themes that both continue to play out and - crucially - still have a long way to run.

Starting with macro trends, the IMF estimates that EM will contribute more than 90% of global economic growth over the next five years, far exceeding the contribution from the US and Euro area in the next five years.

In part that’s because the population of working age people in EM will grow 0.81%, on average, per year between 2019 and 2050, while it will decline 0.3% per year in developed markets.

And as this demographic shift plays out, EM economies are increasingly driven by consumers.

As more workers are brought into the labor force, the consumer base is expanding, and consumers are shifting their wallet share towards discretionary consumption and premium goods like high-end spirits, beers, cosmetics and autos.

Trends like these are driving a digital transformation in EM. Demand for consumer goods and services is increasingly shifting online, and companies producing consumer goods are investing in automation and R&D to boost their output and drive product innovation.

But for all the advances above, EM residents remain unbanked, with the World Bank and UN estimating that more than 900 million people don't have bank accounts. We believe this augurs strong growth prospects for financial services, like bank accounts and loans, and this remains a key theme.

Valuations remain attractive

We see ample evidence that these drivers remain intact. Given the acceleration of some of these trends – we believe that it is time to act now.

Valuations have recovered so far in 2020, and are now in line with historical averages. Importantly, currencies remain cheap, so current valuations could make for nice entry points from a long-term perspective.

EM real effective exchange rates are at a cheap level

Active management can deliver

Finally, we believe an active approach is essential to capturing the opportunities within the above trends.

In the short-term we believe this is especially true. Given COVID and geo-politics, including US elections and US-China relations, market volatility will remain in the coming months, and that provides good conditions for active managers.

Looking more generally, EM offer many opportunities for active investing. EM are relatively under-researched compared to developed markets and are evolving rapidly.

That means official benchmarks may not capture emerging companies, which creates opportunities for active investors with experienced and local teams to exploit under-appreciated opportunities.

Against this backdrop, and with attractive valuations, accelerating themes, plus more fundamental long-term trends, we believe there are good prospects for growth in EM over the next three-to-five years, so contact us today to learn about how to capture the opportunity.


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