Many investors view emerging market economies as a homogeneous block, when they should be looking for returns at the country level, explains Gordon Fraser.
Over the past decade, about 63% of stocks in the MSCI Emerging Market Index moved by at least 40%. While many investors may regard this volatility as a negative, it does mean that, if bought at the right time, a large number of companies offered a potential 40% uptick in return.
That’s why we believe taking short-term, tactical, investment decisions based on individual country cycles, as well as embracing market volatility, is better than a “buy and hold” approach when it comes to emerging markets.
However, one of the most common questions for investors to ask is ”where are we in the emerging market cycle?”
Many are surprised to hear that emerging market countries are often at very different stages of the economic cycle, which we define as sell-off, healing, liquidity on, and activity surge as illustrated in the chart below.
We believe that emerging markets are cyclical in nature. The peaks of the cycle tend to arise during the periods of high growth and inflation, accelerated activity and overheating in the economy.
The troughs tend to arise out of periods of currency pressure, and the consequent response of policymakers to tighten into a downturn to defend their currency.
In line with our investment approach, we don’t view emerging markets as a homogeneous block and instead look at the direction that each constituent country is travelling to generate returns.
For instance, we would rather invest in a country that is currently in a bad state, but has an improving macro picture than one with a good, but deteriorating economy.
We’ve defined four parts of a full emerging market cycle, and we tend to talk about individual countries sitting in one of these at any given time.
Right now, we are cautious on the domestic drivers in South Korea.
The South Korean environment is deteriorating, with many of the policies implemented by the incumbent government backfiring. This has put pressure on wage growth, which has subsequently had a negative impact on the property market. While the domestic environment is getting worse, we are still holding interesting international single-stock opportunities.
In Latin America, we remain exposed to Argentina and Mexico. While elections and inflation are weighing on the Argentine market, we view it as a chance to add to our investments, believing that the potential for significant upside compensates for the risks. Economic reform in the country has largely tracked ahead of expectations in our view, especially early on, and Argentina has achieved a positive oil balance for the first time in years.
In Mexico, external conditions, and particularly the fixed income markets, are signalling an improvement. We believe that the country is being overlooked by the market given the current negativity around domestic politics.
Looking to Emerging Europe, we continue to favour periphery countries such as Greece, where valuations remain cheap, and the recent proposals to clean up the banks without capital raises interesting possibilities that should lead to higher valuations, while also increasing the ability of the Greek economy to grow faster.
We are more cautious on Turkey, which appears to be in trouble given policy missteps from the central bank and political volatility around contested elections.
China is a big part of our investment universe as it represents 33% of our benchmark (MSCI EM). And this will keep expanding with the continued opening and recognition of the domestic A-Share market by global indices.
We have been increasing exposure to China since the start of the year amid improved liquidity and fiscal support. The credit stimulus announced at the start of the year is very significant and will underpin growth for this market for the next few quarters.
In Brazil, volatility surrounding the passing of pension reform remains. In terms of country and regional exposure, we continue to prefer Mexico to Brazil in Latin America.
In Thailand, we don’t expect the market to do much as policy looks to offset weak GDP and the market is expensive. Tactical opportunity still exists in certain segments.
We are most constructive on Indonesia, which we see as being supported by improving liquidity and credit growth trends.
However, in India, the combination of stretched market valuations, recent elections and tensions around the financial system have not been very conducive to market performance and have brought volatility. We have cut our exposures, but will look to reinvest once visibility improves.
A country-specific investing approach to emerging markets offers investors greater detail on how to navigate this complex and volatile market.
Gordon Fraser is portfolio manager in BlackRock’s Global Emerging Markets Equities team.