The banking sector woes illustrate the changing roles of developed and emerging markets quite nicely. After an initial panic flight to “safety” when the crisis first broke, global investors have since returned to the emerging market banks and helped many of them to record share price highs. The attraction is that – in the best possible sense – they are quite boring business, doing the simple things of mortgages and retail loans on which they can earn a healthy margin in their markets, in contrast to the more free-wheeling and aggressive practices of some developed market banks that caused them to become unstuck. Not only that, but emerging market banks still have a large runway for growth, with many emerging economies still very much under-served in terms of financial services.
Looking at the bigger picture, something that makes us feel optimistic for the foreseeable future in emerging markets is that a couple of previous headwinds – China’s ‘zero Covid’ policy, and the strength of the US dollar – have turned into tailwinds as China opens up again and the dollar weakens. Slower US growth (which avoids a bad recession) is healthy for emerging markets, in our view, because it encourages capital flow out of the US into international markets in search of higher returns. After all, the differential in economic growth rates has always been one of the main attractions of emerging markets for equity investors, and the more that differential is able to shine the better that is for sentiment around the asset class.
Although our view on the prospects for emerging market equities is bullish, of course it is important to acknowledge the risks. One of the things that could de-rail the story is if, perhaps triggered by Fed policy mistakes, the US economy enters are deep recession. That would be bad for many risk assets, emerging market equities included, and it is certainly a plausible outcome – although not our base case.
In terms of managing their own economies through tough times, emerging markets simply have more policy levers to pull than their developed markets peers. For one thing, they are not typically having to unwind a decade of extremely loose policy into a backdrop of stagflation. Brazil is the most obvious example, as it has interest rates of 13.75% and inflation that is 4.5% and falling – arguably Brazil should have been loosening policy before now, but it’s only been postponed, not cancelled, and when the rate cuts do come it should be very positive for equity markets.
Beyond that, the two emerging market countries where we see the most attractive opportunities right now are India, which has incredible domestic growth potential, and Taiwan, which is emerging from the trough of a post-Covid export slump and markets are now starting to look ahead to future growth. We’re more neutral on China, which has been a bit of disappointment this year as the benefit of the end of ‘zero Covid’ takes longer to materialise than many people hoped, and US relations have soured once again.
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