A post-COVID-10 world might just be emerging market equities’ time to shine

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By Anthony Doyle, Cross-asset Investment Specialist, Fidelity International

As COVID-19 battered the world’s economies last year, emerging markets were among some of the hardest hit; they also saw one of the better recoveries when equity markets rebounded towards the close of 2020.

This strong recovery has hit a few head-winds though, with fresh or continuing waves of COVID-19 putting differing levels of pressure on several nations. For instance, China, Korea and Taiwan’s economies have remained relatively open, while India and Latin America suffered greatly.

The resurgence in both the US economy and the US dollar also have the potential to hinder the emerging markets’ progress. Still, in April the International Monetary Fund raised growth projections for emerging markets to 6.7% for the year; up 0.4% in just three months.

Much of this is down to vaccination rates beginning to trend up after having started out slower than expected in the first half of the year.  For context, the median emerging market economy has fully vaccinated 12% of its population to date, a number that is expected to accelerate materially to about 65% by year end. 

So, how are emerging markets tracking at the moment?
As at July 2021, the MSCI Markets Index was up 8% in Australian dollar terms. For all its suffering in 2020, Latin America has performed well this year, largely buoyed by Brazil. This is followed by markets in Europe, the Middle East and Africa (EMEA) and Asia.

From a sector perspective, healthcare, energy, and industrials have posted strong gains, followed by materials and financials securities. Real estate, consumer discretionary, communication services, and information technology have lagged. However, a key consideration for all economies – no matter how developed – is whether we will see the return of inflation any time soon.

From a macro perspective, the roll-out of vaccines that we are seeing across the world and the opening of economies have resulted in a sharp pick-up in global activity momentum. This has led to shortages in several inputs such as semiconductors, leading to mismatches between supply and demand, pushing up prices of consumer durables such as cars. Combined with base effects related to the COVID-related activity collapse last year, some measures of inflation are now at their highest levels since the 1990s.

But we believe this stimulus/re-opening fuelled demand bounce has likely peaked and should drop-off towards year-end as stimulus is phased out and savings are partly depleted. Additionally, our bottom-up analysts are telling us that the vast majority of the supply chain and disruptions that we have seen are already beginning to resolve themselves.  Much will depend    upon how inflationary expectations develop from here and whether central banks will respond.

Recent surges in commodity prices have also fueled speculation that inflation will return, and this is a good thing for many countries, particularly those that rely on exports.

Unfortunately, not all emerging market countries are created equal, and the impact of rising prices will differ broadly as not every emerging market benefits from an inflationary environment. But overall, the potential for growth in emerging markets is significant, with certain sectors already competing on a global scale – individual companies too.

For example, as the world’s largest contract chipmaker, Taiwan Semiconductor Manufacturing Company (TSMC) is responsible for almost all of the world’s chips. It’s also one of the top holdings in the Fidelity Global Emerging Markets Fund.

As a global COVID-induced chip shortage wears on, TSMC stands to benefit. The US is in particular need, and TSMC has very recently announced plans to expand stateside and build new factories to meet demand.

Similarly, India’s Tata Consultancy Services is the world’s largest IT services company by market capitalisation. Reported in early July, the company’s Q1 net profits were up nearly 30% year on year and plans to expand its US operations are underway; hiring more than 220 employees in the next two years. Tata also is in the Fidelity Global Emerging Markets Fund.

It’s investments like these that saw the Fidelity Global Emerging Markets Fund return 34.68% in the year to August end. Over the same period the benchmark, the MSCI Emerging Markets Index, returned 22.56%. The pandemic aside, since its December 2013 inception the fund has returned 13.41%, beating the index’s 4.42%.1

While some of the fund’s holdings have already made a name for themselves, Fidelity sees increased opportunities for emerg ing market equities to disrupt global companies. For example, domestic companies and brands are challenging established developed market companies in the consumer discretionary and staples sectors. In sectors like industrials, con struction, chemicals, and heavy equipment local emerging market companies are gaining market-share and consolidating the market.

Fidelity have also seen new business models developing in e-commerce, fintech and financial products which are disrupting old and legacy businesses.  All said, the outlook for emerging markets is positive, with emerging market economies with large domestic consumption to benefit from disruption of supply chains over the short to medium term.

The rise of regional economic centres, where growing demand from a large economy like China or India, will also fuel growth in other developing countries nearby. Couple this with strong domestic consumption as a result of a rising middle class and the evolution of growth industries, and there is quite a compelling case for investing in emerging markets.

Because of the risks associated with emerging market economies, they often generate higher- than-average returns for investors. Not all are good investments, but for those investors willing to research and focus on iden tifying high quality names, emerging markets will remain an attractive proposition for some time yet.

1The fund inception date: 16/12/2013. Total net returns represent past performance only. Past performance is not a reliable indicator of future performance.

 

For more information on the Fidelity Global Emerging Market Fund as a Managed Fund or Active ETF visit fidelity.com.au. This is a modified version of the article first published in the Financial Standard on 12 July 2021. This article is general information and does not consider the circumstances of any investor or constitute advice. No fund or stock mentioned in this article constitutes an offer or inducement to enter into any investment activity.

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