Emerging markets - a recovery in sight?

There can be no doubt that 2018 was a disappointing year for emerging-markets (EM) equity investors. Rising US interest rates, a strong dollar and fear of new tariff barriers hit confidence in EM.

Since the beginning of this year, however, there has been much to suggest a turnaround. Above all, the risk of US interest rate increases has faded. In Asia in particular, growth expectations have also recovered in the last few months. Until very recently, the US-China trade dispute even seemed to be calming down. However, US President Donald Trump’s most recent statements have darkened the skies once more.

Asia's economy back on the growth path

As early as January, leading indicators pointed to a clear recovery in global exports, which are a good proxy for the state of global trade. Together with robust domestic demand in Asian markets, this supported the idea that the world economy was gradually recovering from the collapse in confidence at the end of last year.

The manufacturing Purchase Managers' Index also pointed to a recovery. The Purchase Managers' Index consists of a survey of the major industrial companies in each country on the economy and order pipeline. In China, the Index almost peaked for processing industries in April, after delivering the sharpest month-on-month rise since 2012 in March. The Taiwanese and South Korean processing sectors were also optimistic about the future. Only in India did the figures fall, albeit from a very high base.

China's economy on course for recovery

China is the key. No other country can react as quickly and forcefully to falling growth as the Middle Kingdom. After last year’s profound uncertainty, the Chinese government initiated a comprehensive economic plan. The primary objective was to stimulate consumer demand to strengthen the economy – in contrast to previous years when China focused primarily on exports. Initial success is already in the bag: the CSI 300 domestic share index has risen by around 30 per cent since the start of the year. Further effects may be expected in the next few months, as companies started paying lower social charges from the beginning of May, for example, and VAT was reduced in April.

Other Asian markets should also experience benefits alongside China. The upcoming elections in India and the recent election results in Indonesia could provide new impetus for the economy. In South Korea, meanwhile, the government has brought in tax reductions and economic programs to stimulate consumption.

Not all emerging markets face a bright future

Compared to Asia, Latin America is more about risks. Brazil, for example, could be in for a sobering shock. The market has been pricing in the new government’s successful reforms since October. But it looks like expectations could be dashed, and economic growth could remain below forecast. In Argentina, it’s already clear that the October elections could escalate the economic crisis, while the political and economic situation remains chaotic in Venezuela.

Always look at the full picture

Over the piece, EM therefore look likely to remain volatile. Instead of applying a broad brush to all EM, investors would therefore be better advised to look at the different regions individually.

However, the past has clearly demonstrated one thing: persistence usually pays off in the long term. Countries such as China, India and Indonesia have been on a stable growth path for years. Increasing prosperity in many EM is also accelerating domestic demand, which in turn further reduces dependence on exports. Political reforms, major infrastructure projects and rapid technological advances are adding further impetus, particularly in many Asian markets.

Against this background, and with economic data recently starting to show growth again, investing in a broad-based index could help to improve portfolio diversification. Allocations to Asian markets may additionally benefit from the expected short-term cyclical recovery there.