As America’s influence over emerging markets wanes and China develops its consumer economy, there are opportunities for investors.
Arguably the biggest reason for the pullback in emerging market equities is owing to the trade spat between the US and China. However, we think that the market reaction has been excessive.
While it’s certainly hard to predict how things could play out, in light of the recent G20 meeting and talks between US President Donald Trump and his Chinese counterpart Xi Jinping, there seems to be a sense that there could be further negotiations and a more conciliatory tone going forward.
Rising US protectionism could act as a spur to some developing economies and encourage more regional trade agreements between emerging markets. We believe that China has a pivotal role to play in that development.
Diminishing US influence over emerging markets
Over the past decade, China has replaced the US as the largest export destination for emerging markets as a whole. It has also usurped the US as the top exporter to Brazil and Thailand, while it has replaced Japan as the top exporter to Indonesia.
China’s economy has become more consumer-driven and this shift can pave the way for other emerging market economies to thrive, leading investors to gain more confidence in emerging markets.
A large and wealthy population of consumers drives China’s massive domestic economy, and we expect to see growth in demand for higher-value consumer products - a phenomenon known as “premiumization”.
Demand for high-end items such as designer handbags and furniture, cars and fine dining has soared to such an extent that China enforces controls over personal imports of luxury items from citizens returning from overseas.
The country has become the world’s second-largest consumer market. The demand for goods and services continues to accelerate on the back of rising household incomes, creating opportunities for consumer-related businesses. Consumption could be an increasingly important growth driver in China and other emerging market economies.
Future leaders in emerging market growth
The current environment could benefit the growth of technology manufacturing in emerging markets outside China.
In the past six years, China has shifted away from manufacturing products for export. Policies unveiled in 2012 at the 18th National Congress of the Communist Party of China were designed to help steer the economy towards a consumption- and service-driven model.
Vietnam and Malaysia could potentially benefit from this situation. Both countries have transportation infrastructure in place, which helps develop logistics and shipping networks to support regional or international trade. China, Vietnam and Malaysia, which tend to have cheaper production costs and labour, could take a bigger share of the manufacturing market.
Major electronics companies already have a large presence in Malaysia, and we’d expect exports of electronic integrated circuits, liquefied natural gas and communication apparatus to potentially increase.
China has also taken a step away from manufacturing garments for export. Again, the US’ imposition of tariffs on Chinese garments could create opportunities for lower-cost manufacturers, such as India and Vietnam. Garment production chains in these countries include major international retail fashion brands.
As the largest emerging market, how China fares in a new era of trade and manufacturing could have profound implications for other emerging markets, and for the global economy at large.
The structural case for emerging markets still centres on growth, demographics and the ability to take a larger market share of global manufacturing, which could allow emerging market economies to ride out, and potentially thrive, in this period.
This is the first part of a three-part series explaining why US influence over emerging markets could be fading. The next article in the series will explain why the rising US dollar should have less impact on emerging markets than some people expect.
Chetan Sehgal is lead portfolio manager at Templeton Emerging Markets Investment Trust.