The investment case appears battered, but even lower returns may look good when the world gets back to normal.
Investing in the coronavirus age involves more damage assessment than forecasting future returns, but it still requires a discerning eye. In a complicated world with a short attention span, it's too easy to fall back on broad brushstrokes: "Hotels are toxic, retail's dead, don't get me started on Emerging Markets…."
Even in steady times there are fewer less-descriptive terms than "Emerging Markets" as an asset class that includes Guatemala and South Korea and Egypt—and China. Today, some of these countries are indeed “swimming naked,” to paraphrase Warren Buffett's vivid advice about what low tide may reveal. Some, however, still have serviceable bathing suits even if they are battered and bruised. Globally, slow growth and low interest rates are likely to fall even more, meaning some of these markets may start to look pretty good if you can read past the alarming headlines.
The conventional investment case for Emerging Markets centers on high-growth economies fueled by expanding middle classes and increasing integration with global trade flows. Choose a country or a firm where policies are more sensible than usual, and the returns may more than compensate the extra risk.
The argument deserves a fresh look as the global economy emerges from a devastating crisis and weak demand undercuts pricing for commodity exporters, and trade expansion may slow further as firms reconsider their dependence on far-flung suppliers amid the risks of tariffs and pandemics.
But the silver lining to all these clouds is that slower Emerging Markets growth may still be faster than what is expected from Developed Markets, if the IMF’s forecasts are to be believed, and the countries themselves can weather the storm. More important, there will be even more money out there chasing even lower yields, making the premium from solid Emerging Markets all the more attractive.
“The silver lining to all these clouds is that slower Emerging Markets growth may still be faster than what is expected from Developed Markets, if the IMF’s forecasts are to be believed, and the countries themselves can weather the storm.”
The winners will need to address three key questions:
Just how bad was COVID-19? The early conventional wisdom was that poor health care infrastructure and crowded living conditions might leave many developing countries ravaged by the disease even as richer countries emerged. That wave of contagion may be poorly recorded or still yet to come, but so far the spread seems much better contained in Delhi, Lagos and Bangkok than in New York, London and Paris.
And there are puzzles among these developing countries. Hotter climates slow the spread of the disease, although that hasn’t helped places like Peru or Brazil. If younger people can resist contagion better, then most Emerging Markets benefit from a population that decidedly skews youthful. Nearly two-thirds of Africans are under 35, but that hasn’t alleviated worries there.
How about growth? If it’s too soon to assess the full damage of the disease itself, it’s far too early to assess the changes it will trigger in global supply chains and demand for Emerging Markets exports. International trade growth may slow amid rising populism and tariff tensions, but it will always make sense to buy from the lowest-cost producers no matter where they are located.
Many Emerging Markets have seen their growth rates slow over the last decade for a variety of reasons, but there are bright spots across Asia. Countries like China and India, of course, depend more on the continuing growth of that vast middle class and they are set to spring back 9.2% and 7.4%, respectively, according to the IMF’s economists. They believe this also bodes well for Indonesia, Malaysia, Thailand, Vietnam and the Philippines.
Are the debts affordable? Emerging Market debt levels have risen steadily over the last decade, and weaker currencies have increased the burdens of dollar debt. The blow has been substantially cushioned, however, as the U.S. Federal Reserve deployed dollar swap lines for South Korea, Brazil and Mexico and a creative repo facility that allowed other Emerging Market central banks to borrow dollars against their treasury holdings. Lower domestic rates have also reduced borrowing costs in local currency from Colombia to South Africa to Russia.
Still, there are victims who were having trouble repaying their debts even before the crisis, like Argentina and Lebanon. A G20 initiative last month to freeze debt payments for 77 of world’s poorest countries is only the start of much longer sets of negotiations about who needs relief and who can still pay. Debt restructuring that shares losses with private creditors may be inevitable but will be messy and can damage future access to capital markets if not handled carefully. How countries adjust to their debt burdens after the crisis will also test the resilience and legitimacy of their political institutions, which may be even more important than actual growth prospects.
The task for the careful investor will be to sort through these considerations to find opportunities where COVID-19 damage is limited, growth looks reasonable and debts manageable. Outside of Asia, Mexico may be a good candidate, especially if the U.S. snaps back.
In some countries, where growth may be weaker, owning debt may prove the better investment. In any case, the new landscape will likely require even more differentiation, discernment and careful reading below the headlines.
(% OF POPULATION)
Source: Bloomberg. As of May 8, 2020.
IMF GROWTH FORECASTS
Source: IMF and Bloomberg. As of May 8, 2020.