Emerging markets: as the pendulum swings, what next?Contributor J.P. Morgan Investment Trust Team
Where are we in the journey of emerging markets?
The term “emerging market” was coined in the 1980s, since then investable indices, products and acronyms have been popularised. Over time, some ideas, like the BRICs – Brazil, Russia, India and China, have given way to more specific, country-by-country investment approaches. Two broad truisms remain: emerging markets account for the majority of world Gross Domestic Product (GDP) growth, with regular consumers in these countries benefitting from improving standards of living.
The demographic arguments are persuasive.
By 2030, the global middle class is estimated to rise by 3 billion people, most of this growth coming in emerging economies.1 From 10% in 2000, Asia is anticipated to comprise 40% of global middle class spending by 2030. This rebalancing is underway: the International Monetary Fund (IMF) expects average GDP growth in emerging economies to reach 4.6% this year, versus 2.1% in advanced countries, with countries such as India far above the 4.6% average2.
Increased spending and consumption should be a signal for long-term investors. As the pendulum swings from West to East in economic terms, how do investors capitalise on this opportunity? Macro ideas, smart sector choices and an eye for company fundamentals are all relevant.
In China, the middle class (those earning between USD 11,000 and USD 43,000) has expanded from 5 million to 225 million consumers. Research from McKinsey suggests that the social transformation is not over yet, and that by 2022 more than three quarters of China’s urban consumers will earn at least $9,000 a year3. India’s middle class is also growing: the number of people earning between $2 and $10 a day has doubled in size between 2004 and 2012, working as vendors, drivers and carpenters4.
At an investment level there are opportunities across sectors. China was previously a minnow in the MSCI Emerging Markets Index, and today it has the largest single country exposure. China has world-leading companies in smartphones, internet technology and banking.
The concern about emerging markets being dragged down by commodities is not as relevant as it once was. Whereas in the mid 2000s commodity stocks made up 38% of the MSCI Emerging Markets Index, today they account for less than half that5. Tech companies like China’s Tencent and Baidu, South Korea’s Samsung Electronics and Taiwan’s TSMC are driving the benchmark. According to the Financial Times, stocks from those three countries have been responsible for more than 70% of the gains in the index this year6.
Of course we should not disregard potential macroeconomic and monetary headwinds. The impact of US monetary policy has historically been a concern for emerging markets. However, we believe that dollar sensitivity has lessened as countries have grown more independent. The current account deficits in countries like Indonesia and India have improved over the long term.
We focus on bottom-up fundamentals, rather than just the influence of monetary policy, the state of the dollar or the global risk appetite. After a period of earnings contraction, last year, earnings grew by 10% in dollar terms7. Research analysts expect 13%8 growth this year, which is in line with our expectations for the next five years.
From social mobility to governance and the dollar, many of the concerns around emerging markets are no longer significant obstacles for overseas investors. Our investment teams are looking at opportunities in areas such as ‘fin-tech’ (financial technology), where a number of Indian companies are successfully managing to penetrate rural consumer bases with low-cost technology. In China for example, Ant Financial, an arm of Alibaba, is 16 times larger than Paypal, yet barely heard of outside of China9.
A cyclical return of confidence, spurred on by economic transformation and company outperformance, will likely define the next chapter for emerging markets. By contrast, there are concerns that returns in developed markets could top out, with average returns over the next 30 years expected to drop below 5%, according to J.P. Morgan Asset Management research published April 2017. By the same token, some feel it may be too late to invest in emerging markets. However, current valuations suggest otherwise. At a current average of 1.68x price to book as at 30 June 201710, valuations are comfortably below long-term averages. Investors are returning, however it is still in its early stages. We have seen a lot of changes to the landscape over the years, and believe that emerging markets should be seen as a staple of investment portfolios as companies and sectors continue to grow.
Our research is driven by local knowledge at a global, regional and the single-country level. J.P Morgan Asset Management offers UK investors country-specific emerging markets investment trusts for Brazil, China, Russia and India. The JPMorgan Emerging Markets Investment Trust plc is a concentration of our 40-strong investment team’s best stock ideas targeting long-term growth across countries. The JPMorgan Global Emerging Markets Income Trust plc offers a dividend income combined with the potential for long-term capital growth to investors in the UK.
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