Investors tend to shy away from developing markets when geo-political risk is elevated as fund flows retrench back to currencies such as the US dollar for protection. Coupled with high rates of inflation across the world and Central Banks in tightening mode, this provides even more reason to think the emerging markets are set for more underperformance verses global equities.
However, an alternative picture could be painted (it takes two views to make a market) that highlights some very notable attractions of emerging markets today, that many investors are choosing to ignore. First, let us look at the headwinds of a rising US dollar and higher interest rates. Rising rates tend to suggest that economic growth is strong and that is supportive to both developed and developing markets. Although growth projections are being cut for 2022, they are still in positive territory with the US looking particularly strong. China appears to have suffered its slowdown last year and (Covid policy aside) looks set to do what it takes to resolve its housing crisis and support investment this year by stimulating its economy.
The US dollar has been strengthening since mid-2021 and is now close to the top of its 8 year trading range. Arguably a lot of the ‘bad’ news is priced in to the Dollar today, which includes the forecasted tightening of interest rates by the Federal Reserve. If we have incremental good news on inflation in due course, some political solution in Ukraine and interest expectations retreating, then there is a case for the US dollar to weaken – thus boosting global growth prospects and providing a tailwind for emerging markets.
Another headwind often cited against emerging economies is higher commodity prices. This is true to some extent and the main concern we have is the impact of soft commodity price increases leading to potential civil unrest due to food shortages. This is how the Arab Spring started in North Africa in the early 2010s. I would say this is the key risk to some emerging markets however many do of course benefit from rising industrial commodity prices, such as a number of Latin American countries including Brazil and some African countries. India is a big importer of commodities, especially oil, but it appears as if Modi will be getting discounted oil from Russia.
So it is not as simple to say that emerging economies are looking attractive as one today. Some will remain challenged, but a number including Zambia, Chile, Argentina, Vietnam and China do offer long term attractions.
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