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Emerging markets - from macro to micro

Nick Price

Nick Price - Portfolio Manager, Fidelity Emerging Markets Fund

The sharp sell-off in emerging markets (EM) equities last year provided good valuation support heading into 2019, with stocks in some markets trading down towards levels last seen during the global financial crisis. Even after the rally we’ve seen in the opening months of 2019, it is notable that the asset class continues to trade at a very wide discount to developed markets.

Emerging markets - from macro to micro

In the near-term, investor sentiment towards EM should be well underpinned by a more dovish Federal Reserve and an easing of trade tensions between the US and China. There are still global and local risks that we need to monitor, but this diverse investable universe continues to provide us with a plentiful opportunity set.

Watching China…

As the largest developing economy – and weighting in EM equity indices – China remains an important driver of the broader EM complex. The Chinese market has been boosted by encouraging trade talks with the US and index provider MSCI’s move to substantially raise exposure to mainland shares which will drive flows going forward.

Following a period of deleveraging, we have also seen a sustained effort from the Chinese authorities to boost economic growth via monetary and fiscal stimulus. Taken together, these factors should lend further support to confidence over the coming months.

Longer-term, the rise of the Chinese consumer remains an area of promise for the selective investor. As incomes rise and preferences evolve, we are seeing a trend towards premiumisation, which is driving demand for goods with higher price points.

In 2018, the market took an incredibly punitive view towards China and the resultant de-rating created a number of opportunities. Although the recent recovery has been robust, the Chinese market remains attractively valued and we see continued scope for re-rating.

Current positioning

Against this more positive backdrop, the Fidelity Emerging Markets Fund remains focused on identifying high-quality companies with sustainable growth prospects and attractive valuations, that offer an attractive level of total shareholder return over the medium to long-term.

Notably, the rising purchasing power and changing habits of EM consumers continues to support the outlook for businesses operating in a wide range of sectors. This spans beyond traditional consumer segments into areas such as information technology and financials.

It is important to note the role played by financial services companies. Unlike the developed world, many individuals in emerging markets are at the very early stages of seeking products such as bank accounts, loans and insurance products.

This gives providers access to a customer base capable of dwarfing that of which we’ve seen in the developed world. This backdrop provides great scope for growth with the likes of Hong Kong-listed insurer AIA Group and India’s HDFC Bank key holdings in the portfolio.

Elsewhere, commodities also play a critical role in EM. Currently oil appears to be finding a sustainable level given Opec-led production cuts – one which provides a better backdrop to assess the environment for producers, without placing too much pressure on the consumer. More broadly, supply restrictions are evident in iron ore and copper, bolstering prices particularly for the former.

As ever, selectivity remains critical and our exposure is focused on Russian producers through holdings in Lukoil alongside steel companies such as NLMK. In Russia, as with most markets, domestic steel prices tend to follow international prices. However, Russian producers are unique in their relatively high level of commodity integration (meaning they have their own supply) and the low-cost nature of these assets.

Large global producers, who typically set global prices, are not integrated. As such, when input costs such as iron ore and pellet prices move up, these producers push this cost through to customers to protect margins. The result being that raw commodity prices rise rapidly, translating to higher steel prices. Iron ore supply disruption significantly tightened the market, to the advantage of these producers.

The political calendar remains busy

2018 was a particularly noisy year for politics in EM with several important elections. In particular, the Brazilian market has garnered much interest following Jair Bolsonaro’s election victory. There is now material hope for change in Brazil, but the likelihood of watered-down reforms presents some downside risks following the aggressive rally we’ve seen in recent months. In Mexico, the new president Andrés Manuel López Obrador (‘AMLO’) has revealed his populist leaning, which resulted in a rapid de-rating. At this stage we are adopting a more cautious stance.

Looking ahead, the political calendar remains with India - and to a lesser extent South Africa - in the headlines. Whilst periods of uncertainty may be unpalatable, we remain positive on India given its structural growth prospects. In the near-term, a more defensive positioning in India seems appropriate, with a strong focus on high-quality companies.

Elsewhere, Russia remains subject to the ongoing risk of further sanctions. However, Russian equities look extremely cheap and the dividend profile of the market is noteworthy, with many companies delivering attractive and sustainable shareholder returns via dividend payments.

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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. Investors should note that the views expressed may no longer be current and may have already been acted upon. 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. 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.