Are emerging markets vulnerable to US and developed world central bank policy, or are they backed by sufficiently powerful secular forces to suggest that the benign environment of the past one and a half years may only be the start of a longer-term positive trend, underpinned by a positive broad-based and improving global economic upswing?
Perhaps unsurprisingly for an investment universe with high levels of hard currency debt, emerging markets have historically shown a high sensitivity to the US dollar. However, we believe that the peak stress to US dollar strength lies behind us. 2017 has surprised on several fronts: stronger and more balanced global growth, positive news from Europe, plus a strengthening euro. This stronger global growth, combined with expectations of low interest rates across developed markets (which in turn implies lower debt servicing costs), is supportive to emerging market asset prices.
Until mid-2016, global developed markets experienced low economic growth and persistently low inflation. The ongoing upswing of global growth and moderate reflation are likely to benefit emerging markets which suffered during the years of weak growth. The current brighter growth outlook suggests a preference for investment themes which profit from an economic expansion.
From our perspective, several emerging markets countries are poised to outperform based on their GDP growth. However, country-level GDP growth alone does not always translate into improved investment returns. There are a number of additional factors to consider—for example, the strength of local corporate governance and the impact this may have on performance.
One example of a secular investment theme which specifically benefits many emerging market countries is their growing youthful and tech-savvy populations, whose incomes and propensity to consume are steadily rising. This, combined with a good supply of investible companies from different sectors, creates compelling investment opportunities.
We see consumer spending, healthcare, real estate, and information technology as the key growth themes in emerging markets.
However, the environment is dynamic. It is influenced by various diverging growth trends, and faces many political and economic challenges including industrialization and the digital revolution. We therefore believe that an active country, sector and security selection, based on exhaustive top-down and bottom-up research, is a prerequisite to add value to emerging markets portfolios.