There is still further room for emerging markets to move higher despite rallying strongly since their March lows, according to French asset manager Carmignac’s Xavier Hovasse, who says there are a number of tailwinds supporting further upside.
In US dollar terms, the MSCI Emerging Markets index has made a total return of 41.62 per cent since 23 March, when markets began to rally following the initial impact of the Covid-19 pandemic.
However, Hovasse – Carmignac’s head of emerging markets equities and a manager on the five FE fundinfo Crown-rated Carmignac Portfolio Emergents fund – said there are reasons to believe that emerging markets can continue to make strong gains.
Performance of MSCI Emerging Markets since 23 March
Source: FE Analytics
Below, Hovasse highlights four potential tailwinds that could help drive emerging markets higher.
Abundant liquidity, likely to remain so
The first tailwind for emerging markets identified by Hovasse is the “unprecedented” scale of monetary and fiscal stimulus that have been launched by authorities around the world in response to the coronavirus.
Measures enacted by central banks and governments to support economies have increased the amount of liquidity in the financial system, including a massive balance sheet expansion by the US Federal Reserve.
And this could be a big benefit for emerging markets as some of this increased liquidity finds its way to emerging markets.
US dollar depreciation cycle vs emerging markets & Asian FX
Another tailwind for emerging markets, according to Hovasse, is the widening gap between the “very loose US policy mix with the less accommodative policies across emerging markets”.
Taken together with healthier current account balances, said the Carmignac manager, this is supportive of a weaker US dollar, particularly against Asian currencies.
Performance of MSCI Emerging Markets vs MSCI World over 10yrs (in US dollar)
Source: FE Analytics
“Historic figures showing US dollar cycles lasting on average five-to-seven years suggest that we could be at the start of a depreciation cycle that could reverse the long-term emerging markets underperformance trend versus developed markets,” he added.
Rebound in economic activity led by China
Hovasse said a third tailwind for emerging markets is that they have suffered less severe GDP contractions compared with US and some other developed markets since the onset of the Covid-19 pandemic.
“After a difficult Q2, emerging market economic indicators are rebounding in Q3 with China leading the way,” said the Carmignac Emergents manager. “Needless to say, the importance of China is a major driver of growth for other emerging countries.”
Reasonable valuations for better earnings picture vs developed markets
Given the strength of emerging market economies since the pandemic took hold, it’s little surprise to note that their companies have a more positive earnings outlook but are nevertheless trading at reasonable valuations.
“Emerging markets are trading at a discount to developed markets, with better earnings picture, providing long-term investors attractive entry points,” he noted.
Notwithstanding the current tailwinds for emerging markets, there are also some long-term structural drivers for growth, particularly in emerging Asia, according to Hovasse.
Emerging Asia is where Hovasse and his team find economies with the strongest fundamentals and have also been finding the largest pool of technology and internet companies at the forefront of the digital revolution.
The digital revolution has been accelerated by the pandemic and lockdown conditions that have forced many to remain at home.
“Asian companies’ dominance in areas like e-commerce, digital payment and mobile banking is creating a gradual shift of economic power towards the east, with China & Korea leading the way,” he explained.
And a burgeoning technology war between the US and China is also beneficial for companies in other Asian countries, he noted. 
“Additional demand for Korean & other Asian countries coming from US companies, cut off from their usual Chinese suppliers,” said Hovasse.
This will encourage Asian tech companies to accelerate investments in new technologies to gain their autonomy and extend their technological leadership, he added.
“The right time to invest in this universe will always be difficult to gauge as there are and will always be some potential headwinds to consider: [a] Covid second wave with (partial) lockdown, upcoming US elections, inflationary pressures resulting from very loose monetary policies, FX pressure…. to name a few,” Hovasse (pictured) concluded.
“However, with today’s improved outlook and attractive long-term growth drivers, emerging markets offer value and deserve their place in a well-diversified portfolio, provided you do it selectively and in a disciplined way.”
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
The €169m Carmignac Portfolio Emergents fund has made a total return of 98.9 per cent over the past five years compared with a gain of 71.16 per cent for the average IA Global Emerging Markets peer and a 81.86 per cent return for the MSCI Emerging Markets benchmark. It has an ongoing charges figure (OCF) of 1.15 per cent.