A US-China trade deal is likely to have the biggest impact on broad emerging market returns in 2020, although the economic backdrop is looking positive and investor sentiment could be improving, according to several fund managers.
Emerging markets have become a consensus overweight position among international asset allocators, with the December edition of the closely watched Bank of America Merrill Lynch Global Fund Manager Survey showing a net 25 per cent of fund managers overweight emerging market equities.
Seema Shah, chief strategist at Principal Global Investors, believes emerging economies could see a bit of a bounce as global growth stabilises early in the year, although investors will have to be selective about where they invest.
“While the macro backdrop appears supportive for emerging market assets, the late-cycle bounce still requires investors to carefully pick their allocations,” she said. “Markets will likely penalise governments who flagrantly reflate their economies without regard for already-sizable debt piles and/or inflationary risks.
“Political risks are likely to become more pertinent in 2020, as pockets of social unrest become more widespread, putting prudent macro policies in danger of being thwarted by nationalistic priorities.”
However, emerging markets – particularly those in Asia – will likely be dominated by one issue in 2020: the US-China trade war.
US president Donald Trump’s pursuit of a more favourable trade relationship for the US has caused a great amount of anxiety in markets as the two superpowers have engaged in tit-for-tat tariffs. However, there is likely to be some movement towards a resolution in 2020 ahead of the presidential elections in November.
Will Lam and Ian Hargreaves, co-heads of Asian and emerging market equities at Invesco, said the trade negotiations are likely to have a significant bearing on market returns and, while some progress has been made, there is still a long way to go.
“The outcome is unpredictable and there is a danger that tensions could escalate further,” they said. “The Trump administration perceives the rise of Asian technology as a threat, particularly Chinese technology, and this backdrop is likely to persist as China continues to spend on semi-conductor development and 5G. The US is likely to remain wary of allowing China access to US technology.”
Chetan Sehgal & Andrew Ness, managers of Templeton Emerging Markets Investment Trust (TEMIT) said while trade deal talk continues to drive sentiment in emerging markets, they are becoming less dependent on developed markets.
“Emerging markets have become far more outward-looking, while also developing stronger trading relationships between each other,” they said. “We believe today’s emerging markets are now more resilient than in previous decades, emerging stronger after periods of economic hardship.
“Many emerging economies learned lessons from the past, building up cash reserves and diversifying away from US dollar-denominated debt.”
Emily Fletcher, co-manager of BlackRock Frontiers Investment Trust, said emerging market equities have recently started to outperform developed market equities and could start to benefit from increased inflows.
Performance of indices in Q4
Source: FE Analytics
As the above chart shows, the MSCI Emerging Markets index outperformed the developed market-focused MSCI World during the fourth quarter of 2019 (to 20 December) with a return of 4.78 per cent.
“Emerging and developed market central banks have been easing monetary policy and this has improved the liquidity environment,” she said. “Given this improvement, we are positive about emerging markets and frontier markets for next year and expect flows and investments to return to emerging market equities despite the macro volatility.”
One area that Raheel Altaf – co-manager of the five FE fundinfo Crown-rated Artemis Global Emerging Markets fund – said is being overlooked is the value part of the market.
“The pursuit of 'safe havens' or mechanically buying into the market’s previous winners – momentum investing – has created an unusually large valuation gap between value and growth stocks,” he said. “Value stocks are trading at unusually depressed levels. At times in the last 18 months this discount has threatened to shrink, but value stocks have not had a persistent period of outperformance.”
Performance of style indices over 10yrs
Source: FE Analytics
The MSCI Emerging Markets Growth index has outperformed its value counterpart over most standard time frames, making a 111.62 per cent gain over 10 years compared with a 56.32 per cent rise for the MSCI Emerging Markets Value index. However, the Artemis manager said different conditions exist in emerging markets than in developed markets and it would be wrong to write them all off.
Altaf added: “Bear in mind too that conditions faced by value stocks in emerging markets are quite different to those confronting their counterparts in developed markets.
“Favourable demographics, increasing urbanization and the need to invest in infrastructure mean the growth prospects for, say, a Chinese cement manufacturer look far brighter than for its European or Japanese equivalent.
“Similarly, the growth prospects for a Chinese bank are much more appealing than for a retail bank in the mature markets of Europe.”
Finally, Ross Teverson, head of strategy for emerging markets at Jupiter Asset Management, said there may be further evidence of swing in sentiment towards small and mid-cap companies in 2020.
“In 2018, we held the view that small and mid-cap stocks had been unfairly sold down by investors as the market focused primarily on macroeconomic concerns.,” he explained. “In 2019, we saw our patience rewarded as the strong operational results of many of these overlooked companies resulted in a positive share price performance.
“We anticipate further value to be realised in these off-benchmark, small- and mid-cap names, particularly if the market begins to look past geopolitical turmoil and focus on fundamentals.”