Emerging markets are likely to remain attractive to investors – especially those using an active approach – in spite of the many coronavirus-related headwinds confronting them, according to Vanguard.
The containment of coronavirus in emerging markets has had varying degrees of success. The swift lockdown and isolation of the disease in China and Taiwan is starkly different to India and Brazil, which are struggling with rising cases and fatalities.
In June, the International Monetary Fund (IMF) cut its emerging markets growth forecast in June for both 2020 and 2021, despite raising its 2021 forecast for advanced economies. The IMF now thinks emerging market GDP will decline 3 per cent this year and grow 5.9 per cent next year.
Against this backdrop, Vanguard senior investment strategist Jonathan Lemco said: “Individual emerging markets are more different than they are alike, and the pace and trajectory of recovery is likely to vary, perhaps significantly, from region to region and country to country.
“The progression of Covid-19, more than anything else, will dictate the terms.”
The uncertainty surrounding the spread of the disease and the potential for future spikes in the second half of the year keep the predictions for Latin America and the Caribbean as pessimistically low, according to the Vanguard strategist.
In April, the IMF had said Latin America and the Caribbean’s economy would contract by 5.2 per cent in 2020. In its June forecast, this was changed to a 9.4 per cent decline.
A revised forecast that changes by more than 4 percentage points is noteworthy, especially considering the outlook for all other emerging and developing regions was reduced by less than 2 percentage points.
2020 and 2021 emerging markets growth outlooks
Source: Vanguard, using data as of 24th June 2020, from the International Monetary Fund.
As of the 9 July, Brazil had 1.72m confirmed coronavirus cases and 68,000 deaths, which is second behind the US.
Mexico, the second largest economy in the region, is second among emerging market deaths from Covid-19, while Peru and Chile are in the top 10 of global confirmed cases.
“So much about virus progression and economic recovery depends on the difficult decisions governments make,” said Lemco. “Early containment measures in many countries in Asia appear to be paying off in reduced disease incidence.”
While governments and central banks across the world were quick to bolster their economies through massive fiscal and monetary stimulus, those in the emerging markets lack the capacity, rather than desire, to respond in similar fashion, Lemco noted.
“They do benefit from the spill over effects from functioning markets,” he added.
New bond issues are being met with greater demand than there is supply and international investors have been enticed by attractive yields in absence of the yields they would expect from developed markets.
The oil slump in March was particularly difficult on a region that largely depend on commodity exports.
“Oil has bounced back in the last two months from prices that had briefly turned negative when broad virus-induced market disruptions were at their greatest,” said Lemco. “But they’re not back to where emerging markets need them to be amid diminished demand and a supply dispute between Russia and Saudi Arabia that has subsided but not disappeared.”
With the US election looming, this raises familiar concerns about the impact of the US-China trade dispute on emerging markets.
Lemco outlines that countries such as Vietnam, Indonesia and Mexico would likely benefit due to the resulting supply chain reconfiguration.
However, the uncertainty of a fractured economic relationship between two major powers doesn’t favour those nations.
Lemco cites the 1997–1998 Asian financial crisis and Russia’s 1998 debt default, which he believes were valuable turning points.
“They’ve acknowledged the economic hazards of corruption, patronage and unconstrained infrastructure development,” he said. “The countries have embraced the importance of low debt loads, sufficient reserves, adequate growth, low inflation, flexible exchange rates and political stability.”
Despite the uncertainty the pandemic still poses, investors will still be drawn to emerging markets because of the growth potential and demographic spread.
“To the extent investors believe that an active approach is best-positioned to capitalise on the differences within emerging markets, we espouse low-cost active as a way to remove headwinds,” the strategist noted.
“Whether investors choose actively managed or index funds, Vanguard believes in the benefits of global diversification, including a portion of portfolios in emerging markets, and investing for the long term.”