Emerging markets (EMs) may be an unappealing area to invest in at present, but their economies will thrive as developed countries fall into recession, according to Justin Leverenz, chief investment officer of developing markets equities at Invesco.
The MSCI Emerging Markets index trailed behind the MSCI World by 160.7 percentage points over the past decade, meaning most investors have overlooked the sector in search of higher returns elsewhere.
However, many central banks throughout these less developed markets began increasing interest rates earlier than those in developed nations, putting them in a stronger position to face upcoming volatility, according to Leverenz.
Total return of indices over the past 10 years
Source: FE Analytics
With inflation rising at a rapid rate across the globe, the Federal Reserve (Fed) and Bank of England (BoE) began increasing rates at the end of last year, with both currently around 1%.
In contrast, interest rates in Brazil and Mexico were raised more rapidly, standing at 11.75% and 6.5% respectively.
While developed nations such as the UK and US are beginning a period of tighter monetary policy, Leverenz said that most of the developing world “has already worked through that pain”.
He added: “Emerging market central banks are not just ahead of the curve, but actually we expect them to be in a position to reduce rates.”
This was echoed by Vipul Mehta, head of Asia Pacific ex Japan at Nomura, who said that the loosening monetary conditions in China made it “a very easy sell” for investors looking for a good deal.
However, he was not fully convinced that things were as good as they seemed, stating: “It's the only country that is loosening and providing liquidity. Now, whether that is a cushion or stimulus is a big question mark – I would say it is a cushion to preventing further downside, so China is in trouble.”
He added that although share prices were cheap, the Communist Party of China’s (CPC) zero-Covid and common prosperity policies continue to make the market too volatile for him to invest.
China has been subjected to huge outflows as international investors are scared off by government interference, with the MSCI China dropping 30.4% over the past year.
Total return of indices over the past year
Source: FE Analytics
Although the outlook for China is still unpredictable, Leverenz anticipates that the market will begin recovering within the next 12 months.
With the Nasdaq 100 dropping 21.8% since the start of the year as the US’s growth stock leaders drop out of favour, Leverenz predicted that there will be “a role reversal in the two largest economies in the world” at some point in the next year.
He said that not only are EM valuations “very cheap relative to US equities”, but they have emerged from this period of economic difficulty with more resilient business models, making them an attractive purchase when that reversal comes.
Companies based in emerging markets have been forced to economise, stripping down their business models to the most profitable streams of revenue.
This focused attention on near-term opportunities has resulted in more “rational and disciplined” businesses, which is different from the US companies that are used to being ambitious and adding new branches to their models that are not necessarily as profitable, according to Leverenz.
This is a process that companies in developed nations will have to endure as higher inflation and a potential recession put pressure on existing business models to re-shape.
With EM equities currently undervalued by global markets, Leverenz said that he doesn’t “believe investors have connected the dots” and found the great source of potential in the area.