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During the fourth quarter, our base case for emerging markets (EM) was the following: we saw favorable economics, questionable politics and an exciting digital disruption theme that swept across emerging markets countries around the world.
As the quarter unfolded, some parts of EM demonstrated significant relative strength in coping with the effects of COVID-19, coupled with an increase in transformative growth trends across a broad range of sectors and industries. New virus cases trended more favorably in emerging markets vs. developed markets (DM). EM fatality rates were lower relative to DM as well. During the quarter, Northeast Asia stood out the most. The region’s success in containing the pandemic and maintaining growth with less stimuli became an anchor for EM currency and equity expectations.
Global growth normalized at different speeds, with EM central banks remaining very accommodative. Core inflation was a little higher but not really moving the monetary needle. Growth reflation without inflation (reverse stagflation) augured well for equity returns but reflected more in earnings rather than multiples. Economic recovery was led by China and other work from home (WFH) beneficiaries. EM real exports turned positive in September 2020; industrial production growth was upward trending in the majority of developing countries; and retail sales and commodities were on the rise as well. Vaccine allowing, we expect global trade to be on track for a V-shape recovery.
Korea/Taiwan benefitted from high tech and cyclical industry exposures. India was steadily getting back to normal. LatAm was the most impacted region, with poor management of COVID-19, but may do well with a combination of the southern hemisphere summer (warmer weather and longer days), followed by vaccine availability. The region is still heavily driven by commodity exports, with fiscal metrics severely compromised (for most countries) as an overall response to the pandemic. This means that LatAm is more dependent than ever on a combination of low global interest rates and a China-led global recovery. Gearing to commodity exports should help in its economic recovery effort as well. Mexico remains highly linked to the economic prospects of the U.S. Eastern Europe has dynamics similar to EU, benefitting directly from normalization. South Africa continued to struggle in economic terms.
With regards to China, challenges exist in its global relations, and that could potentially impact EM investing in the future.
During the period, we also saw a remarkable acceleration of digitalization across emerging markets that created ample opportunity for investing in forward-looking, sustainable and structural growth companies in the space. Undoubtedly, the scale of digitization offers unique opportunities for continued investment in innovative and disruptive issuers. However, valuations became a bit more challenged given the current market environment.
Clearly, we are in extraordinary times. We expect a more optimistic one-year outlook, driven by further optimization in virus control when vaccines are available and distribution schedules are in place, the U.S. election finally being behind us, and global investors feeling more confident in the outlook for emerging markets. A key driver of our outlook for 2021 and beyond is an expectation of global growth recovery, boosted by COVID-19 vaccine availability and logistics in place (e.g., EM regulatory approval, mass production and distribution schedule) – that should help catalyze a faster normalization in emerging markets economies around the world.
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. Whilst we can’t say exactly how all businesses will recover, we can say, with conviction, that the Emerging Markets Equity Strategy is well positioned for the future of emerging markets.
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