In my last blog post from June, I encouraged readers to look beyond China for emerging market (EM) equity opportunities against the supportive macro backdrop of unprecedented global stimulus, a low but improving purchasing managers’ index (PMI), and a weaker US dollar. I recommended that investors favor corporate business models that are likely to deliver resilient, better-than-expected earnings growth going forward.
Fast forward to August: I remain constructive on EM equities overall and believe we are on the cusp of several quarters of EM earnings recovery and upgrades.
What has changed since June?
Back in June, I believed that the countries on the clearest recovery paths from COVID-19 — North Asian markets like China, South Korea, and Taiwan — warranted the largest EM exposures in investor portfolios. At the time, I also suggested that investors begin to diversify their EM allocation into “laggard” markets like Russia, South Africa, Brazil, and Mexico. So what’s changed?
North Asian markets: Today, the North Asian markets continue to grind higher on the back of stronger macroeconomic data and more upbeat investor sentiment, but, of course, that means their valuations are climbing as well — especially in market-leading sectors like technology, consumer, and health care. I am therefore still positive on these markets, but have become somewhat more selective as valuations have risen. In South Korea, for example, consider looking for companies with underestimated power to dominate its growing digital ecosystem, as well as potential beneficiaries of the country’s recent flow in online retail-brokerage assets away from bonds and housing into the stock market.
Other EMs: Meanwhile, much of the rest of the EM universe remains overlooked by investors, despite showing signs of a revival. I believe some stocks could grow 50%+ over the next 12 – 18 months, driven by falling capital costs and overly muted earnings expectations. Second-wave fears persist and must be monitored, but, thus far, have presented buying opportunities. In Russia, for example, I expect the economy to bounce back in 2021, aided by the central bank having room to cut rates. I think financials, particularly large banks, may be a good place to invest at this stage of Russia’s cycle. In addition, Russia’s e-commerce adoption is at a nascent stage compared to China and South Korea.
Broadly speaking, the three main catalysts for a sustained EM equity rally — ample liquidity, a global economy on the mend, and an earnings recovery cycle — appear to be in place as of this writing. The key for investors (as always) is to target EM countries, industries, and individual stocks with the greatest upside potential.