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Emerging markets are in the process of economic healing despite the uneven impact of COVID-19. Lower rates and higher fiscal spend have created a significant rebound, but at what cost? We strive to isolate the truly exceptional, structural growth companies from the noise and market volatility of ongoing macro events. Additionally, it is worth pointing out that risk aversion has disproportionately affected small- and mid-cap stocks in emerging markets. As markets normalize, we believe it is reasonable to expect relative outperformance from these smaller stocks. As a “true” all capitalization strategy, these changes in sentiment can materially affect the relative performance of our portfolio.
As the third quarter unfolded, so did the ongoing rebound of emerging markets economies. Easing of virus restrictions, coupled with supportive emerging markets government policies, boosted growth across emerging markets. Indeed, emerging markets governments around the world continued offering fiscal stimuli, including discretionary easing and loan guarantees. Additionally, our expectation is that core emerging markets central banks will maintain their commitments to keep monetary policy accommodative well into 2021.
China, in particular, has been well positioned for economic recovery in the third quarter and continues to move full steam ahead with gains in investment, industrial production and services activity. Although the country was impacted by the virus first, it took timely and decisive steps to contain its spread and further monitor it through extensive testing, diligent contact tracing and ongoing follow-up. Ultimately, China’s economy benefited from being less dependent on sectors and industries affected by COVID-19, such as international travel and tourism, and more dependent on its export activity, primarily driven by the country’s significant market share in sectors like healthcare and technology. China has achieved a better economic outcome compared to many other emerging and developed market countries, despite the fact that its overall stimuli has been relatively restrained.
With regards to EM Asia (ex-China), this group is on its way to economic recovery as well. However, COVID-19’s impact is highly divergent across the region. Virus control measures have been lifted for the most part, but the situation remains problematic in some countries. For example, India, Indonesia and the Philippines continue to face increased rates of COVID-19. Domestic activity and regional trade picked up during the quarter, whereas services activity remained well below normal levels.
Some countries in Latin America have also struggled to control the virus, and unfortunately tend to have a smaller amount of “wiggle room” to address these challenges.
Clearly, we are in extraordinary times. We expect a bumpy first half of 4Q 2020, primarily driven by uncertainty surrounding vaccine news flows, the upcoming U.S. election and somewhat negative investor sentiment towards emerging markets. But, we expect a stronger finish to the year and a more optimistic one year outlook, once vaccines are available, the U.S. election is over and investors feel more confident in the outlook for emerging markets. A key driver of our outlook for the end of 2020 and beyond is an expectation of global growth recovery, boosted by a timely introduction of a COVID-19 vaccine and its distribution schedule.
The consequences of the global pandemic juxtaposed with truly unprecedented monetary and fiscal stimuli will be with us for many years to come. Emerging markets have traditionally underperformed in a risky environment, but in general, we believe the behavior of the asset class has not been as bad as many might have predicted. A large part of the negative outcome in the first stages of the pandemic was generated by the abnormal strength of the U.S. dollar, driven by a global “shortage” of dollars. Aggressive central bank action has “normalized” the situation, and we continue to have a reasonable hope for U.S. dollar stability (or, dare we say weakness) in the coming quarters. Whilst it may not matter in the shorter term, we think emerging markets currencies are cheap, particularly versus the U.S. dollar.
Investing in emerging markets is for the long haul.
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