Emerging markets: another feast for value investors?

Graham Smith

Graham Smith - Market Commentator

“If it’s obvious, it’s obviously wrong” (sic) is an adage most famously attributed to the twentieth century financial author Joe Granville. It might stand us in good stead. It makes sense, when you think about it, that something that’s obvious about a market to everyone will most likely already be factored into share prices. It’s the unexpected – the unobvious – that is much more likely to cause prices to move one way or the other.

Emerging markets: another feast for value investors?

It could be argued that the year so far has been a good case in point. In the midst of deep and intensifying concerns about Brexit – both leading up to and now after the 29 March deadline – shares in companies greatly exposed to the UK economy have been moving up nicely¹ since the end of last year, and it was by no means certain that they would. Yes, valuations were low; but they had been that way for many months.

Which brings us – none too smoothly, I’m prepared to admit – to emerging markets. They too appeared to offer good value at the end of last year. The discount applied to them seemed to defy the logic that superior rates of economic growth deserved premium ratings.

The reasons for steering clear though seemed obvious. A strong US dollar and flying US economy were two of the main ones. A strong dollar makes it harder and more expensive for fast growing emerging markets to keep that growth going through borrowing in dollars.

At the same time, a strong dollar and booming US economy lessen the urge among investors to pursue growth in riskier markets. Last year, it was easier – and less risky – to enjoy the Trump inspired boom stateside.

Since the start of 2019 though, emerging markets have rallied strongly². There may well be continuing trade tensions between the US and China, the uncertainties posed by a forthcoming general election in India and unresolved issues to worry about in Latin America – Argentina and Venezuela especially – but markets have regained a good deal of composure.

Put another way, the problems that were obvious to everyone ultimately proved no barrier to prices rising.

The question now is, can these trends continue?

Arguably there is now less of a consensus either for or against emerging markets than at the start of the year. Since then, America’s central bank has scaled back its outlook for interest rate rises this year, to the point where markets are, broadly, no longer expecting any. That should relax the pressure on emerging markets caused by dollar strength, at least temporarily.

At the same time, all the talk is of a US economy slowing down – another reason shortening the odds the dollar will flag this year. The flipside is that a US economy that is less strong has implications for world growth, a matter important to the health of emerging markets.

Meanwhile, though China has taken steps recently to stem its economic slowdown through measures like cuts in taxes and fees, it seems unlikely that moves like these can really take the place of the big spending on infrastructure employed in previous slowdowns.

China’s insistence on placing domestic consumption at the centre of the agenda while downgrading exports and public investment may have long term benefits; but it remains a drag on out-and-out growth in the meantime.

Another reason for caution is that general elections can be expected to figure somewhere in the fortunes of a number of emerging markets this year, including Indonesia and South Africa. India entered a crucial general election process this week that will test the public support for Prime Minister Modi’s ambitious reform agenda.

Russia’s economy has been rolling along quite nicely of late, with growth reportedly rising to its highest in six years in 2018³. This performance has come despite sanctions and an agreement with OPEC to limit oil production.

The Mueller report in America, which concluded last month there was no collusion between Russia and Donald Trump’s 2016 presidential campaign, is a positive in that it lessens the chances of a further tightening of sanctions this year.

Before we get too carried away with that though – and the valuation of Russia’s stock market, which remains severely depressed despite recent strong price gains – very low levels of non-government investment and a strong squeeze on household incomes remain significant causes for concern⁴.

Positively, and despite the panics we saw in Argentina and Turkey last year and in Venezuela thereafter, the economic fundamentals of the vast majority of emerging markets look good.

This week, the International Monetary Fund said it expects emerging markets to grow on average by 4.4% this year, picking up to 4.8% in 2020⁵. That’s important, not least because it was growth that helped emerging markets to perform well even as US interest rates were rising between 2004 and 2006⁶.

You might expect emerging markets growth to come at a price, but it still doesn’t, even after recent gains. At the end of last month, the MSCI Emerging Markets Index traded just 13 times the earnings of the companies it represents, compared with around 18 times for world markets generally⁷.

Fidelity’s Select 50 list includes several that encompass a range of emerging markets. This makes a good deal of sense for what can be both a highly rewarding but also unpredictable asset class.

The Fidelity Global Emerging Markets Fund currently has almost 60% of its portfolio invested in Asia, with large holdings in the Hong Kong insurer AIA Group, India’s HDFC Bank, Taiwan Semiconductor and the Chinese internet retailing giant Alibaba.

The Asian growth theme is reflected in several other selections. The Stewart Investors Asia Pacific Leaders Fund is one. It focuses on companies that contribute to, and benefit from, economically and environmentally sustainable development, an approach gaining traction in a world increasingly attuned to sustainability issues.   

More on Fidelity’s Select 50

Source:
¹ Cboe Brexit High 50, 09.04.19
² Bloomberg, 10.04.19
³ʼ ⁴ Reuters, 12.02.19
⁵ IMF, 10.04.19
⁶ʼ ⁷ MSCI, 31.03.19

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.