Unpacking Emerging Markets

by | October 19, 2020

Over the coming few weeks, three topics will vie for the markets’ attention: the US November elections, surging Covid-19 infection rates in Europe and the US, and the results of the ongoing third quarter corporate earnings season.

We have addressed each of these three topics extensively in recent Market Compass pieces and will surely return to them over the coming weeks. But now, we’d like to draw attention to less-well followed developments in emerging markets and what they portend for investors.

Emerging markets are typically viewed by both investors and the media as a distinct asset class. The rationale is straightforward. Emerging markets represent faster-growing parts of the world economy, and precisely because they are ‘emerging’ (i.e., leaving behind troubled pasts) they typically demand higher risk premiums, reflecting weaker policy, political or economic institutions than their developed country peers.

However, it is easy to fall into the mental trap of believing that faster growth and a distinct emerging risk premium make for a cohesive asset class, one with a homogenous return profile.  By classifying emerging markets as a separate asset class, investors run the risk of ignoring fundamental differences among them.

The events of recent years—trade conflict, geopolitical risk and the Covid-19 pandemic—have laid bare that extreme differences exist among emerging economies, separating the best from the rest as regards emerging equity, fixed income and currency markets.

In the course of 2020, for example, the Chinese renminbi and Chinese equity market have turned in stellar performances relative to both emerging and developed markets. Year-to-date the renminbi has appreciated nearly 4% against the US dollar and a whopping 44% against the Brazilian real. This year China’s main equity index has thumped the S&P500 by some 13%, while outstripping Brazil’s equity index by more than 60%.

Indeed, a cursory glance at emerging equity and currency markets betrays a north Asian bias. Year-to-date emerging currency and equity gains are found in China, South Korea, Taiwan and India. In contrast, equities and exchange rates have slumped in Brazil, Russia, Turkey, Indonesia, Colombia, Chile, South Africa and Mexico.  Divergences in 2020 among emerging markets are significantly greater than between emerging and developed markets.

What explains the massive performance gap in emerging markets this year? One factor is public health, specifically pandemic control. With the exception of India, 2020’s basket of emerging winners is comprised of countries that have managed Covid-19 relatively well. Partly, successful pandemic control may reflect prior experience, for instance with SARS, that prepared their societies and public health institutions for more rapid and effective containment measures. As a result, countries such as China, South Korea or Taiwan have been able to sustain economic re-opening in ways the confounds other countries and regions, including much of western Europe and the US.

Financial strength is another factor. Larger, more diversified and higher income north Asian economies have been able mobilize economic and financial support more readily than poorer, more financially strapped emerging economies in Latin America, much of Africa or lower income Asian countries.

In contrast, the extent of a country’s open borders — as measured by trade’s share in GDP — is less relevant. India and Indonesia, for example, have similar shares of exports to GDP (roughly 19%). Yet India’s equity market has eked out a small 2% gain this year, while Indonesia’s has lost more than a quarter of its value.

Instead, the sector composition of exports (and national income) has been decisive. Less well diversified, raw materials producing or cyclically sensitive emerging economies such as Indonesia, Russia or Chile have turned in some of the worst equity or currency performance this year. That accords with the sharp underperformance in global equity markets of sectors such as energy or basic materials. Emerging markets with a strong presence in information technology, such as Taiwan or South Korea, have done much better.

Idiosyncratic risk remains important. Mexico, for instance, has languished not only because of exposure to underperforming industries such as energy or autos, but also because of its political, geographic and economic proximity to the US and attendant uncertainties unleashed by a more protectionist America.

Nevertheless, the mosaic presented by emerging markets this year resembles that of the broader 2020 investment themes. The best performing characteristics in global equities include reliable growth, underpinned by solid foundations. Cyclical exposure has lagged and cheapness (value) has extended a decade of underperformance. The same can be said about the relative winners and losers in emerging markets.

What broad investment conclusions can we draw for the period immediately ahead? If the US election results diminish political uncertainty and improve the prospects for sustained policy support to support economic recovery, and should pandemic risks recede, then investors will revisit the most beaten down emerging equities and currencies, just as they will see value in cyclically sensitive sectors elsewhere. But in the absence of more positive news, the emerging performance gap will remain large or even widen further.

Put differently, global risk premiums will dominate relative emerging market performance for the foreseeable future. Emerging markets are worthy of our attention. Emerging economies have much in common. But they have never been homogenous. Frequently, their differences matter more than their similarities. It may have taken the crises of 2020 to drive that point home, but it is a lesson that emerging investors shouldn’t soon forget.

Filed Under: Economics

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets.

Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy.

Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland.

From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT.

At both GAM Investments and UBS Investment Bank Larry was widely recognised for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others.

Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides commentary and analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved.

Friedman is a senior business leader with two decades of experience growing and transforming businesses in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank.

Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard.

Friedman served as a White House Fellow in the Clinton administration and as an assistant to the Secretary of Defense. He is a member of the Council on Foreign Relations and the Chairman of the Advisory Board of Project Syndicate, the non-profit opinion page that provides world-class commentary to over 500 newspapers globally. In addition, he is a board member of the American Alpine Club and the Jackson Hole Community Housing Trust, and has served on the boards of the Gates-Cambridge Trust, the Seattle Art Museum, and a number of other non-profits. 

Friedman is a regular contributor to several newspapers and thought leadership groups and has published numerous opinion editorials on topics including economics, finance, philanthropy, and politics in Project Syndicate, Bloomberg, The Wall Street Journal, The Financial Times, The Guardian, CNBC, The South China Morning Post, The Chronicle of Philanthropy, and other news outlets. He is also the author of Babu’s Bindi, and The Big Thing, both children’s book.

An avid mountaineer and rock climber for 30 years, Friedman has climbed some of the world’s highest mountains and led the first major climb to raise money for charity through an ascent of Mt. McKinley.

He holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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