The Bull and Bear Cases for Emerging Markets

Thursday, December 14th, 2017

It has been a good year for emerging markets, which have outperformed developed markets by over 15% ytd (source MSCI/Bloomberg). It seems possible that this trend could continue as emerging markets have only just begun to make up for the ground they lost in the prior six years.

One of the key drivers behind this resurgence is the stabilisation in commodity prices and the synchronised global growth seen over the course of the last 18 months. Both of these have been tied to excellent growth from China as their central government’s policies evolve the economy from one focussed on exports to one that focusses on domestic demand.

Emerging Markets are attractive in the long run because they benefit from some broad trends; soaring urban populations, globalisation and a low base, where small improvements can have a seemingly disproportionate impact on the country’s output. Best of all, they generally have a blank canvas and can adopt technological innovations without having to work around legacy systems. The economic outlook of many of these countries is good, led by improving standards of living.

We are particularly interested in China. Domestic consumption in China has taken off in the past couple of years and will likely carry on for the foreseeable future. This trend has been supported by the government whose policies are driving consumption. We want to access any business that benefits from the growing sophistication in the country’s technology, rapid adoption of e-commerce or urbanisation is driving more people to the cities (where wages are higher).

Chinese consumers are also taking on debt and this is further supporting very fast growth in consumption spending. In the UK, consumer debt to GDP is at 150% whereas in China it is less than 50% so there is a lot of scope for China to extend its spending, although there is a lot of debt in other areas of this market.

The simple message to take away is this: it’s not going to be a smooth ride, but the long-term opportunity should make it worthwhile.

Bull:

  • The rise of the Chinese consumer is driving growth in the sector and across Asia.
  • Drop in dollar benefits purchasing power of emerging currencies, reducing the cost of their dollar debt and improving their trade balances.

Bear:

  • Cautious of general allocation to emerging markets as there are a lot of state owned companies in the index whose focus is not always aligned with shareholders as they often are required to fulfil a social need, such as employment.
  • While we like most emerging market equities, we are cautious of their debt as yields don’t seem to compensate for the risk.

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