Middle class and domestic growth provide best EM stockpicking opportunities
Investors in emerging market equities need to target sectors of domestic growth through careful stock-picking for the best returns as the complex outlook means they can no longer rely on riding the wave of U.S. economic recovery.
The emerging markets are also benefiting from a number of global trends. These tell us that, inter alia, by the year 2050, the world’s population will have topped the 9.3 billion mark (source: World Bank). The emerging markets are forecast to show the biggest jump: they will account for more than 85% of the population. Emerging-market purchasing power is also on the rise. Estimates disclose that, by 2030, the middle class will have increased by around 2.5 billion and there’ll be twice as many households as now with an income of more than $6000. This will make these markets the drivers of global consumption. Going by recent EIU and IEMS studies, the number of emerging markets shall consequently account for around 40% of global consumption expenditure by 2030 (as opposed to less than 20% in 2000).
The positive and negative factors affecting emerging markets are delicately balanced and extremely complex. These range from the impact of the U.S. economic recovery, a stronger dollar, landmark elections and market restructuring in Asia to volatile geopolitics from Eastern Europe to the East China Sea. In such a fluid market environment, a cross-border thematic approach with a particular focus on domestic market growth stories — such as the relentless rise of online commerce — is most likely to achieve the best risk-adjusted returns.
The usual boost to emerging market export sectors from the U.S. recovery may be tempered by the strengthened competitive position of the world’s largest economy in global markets as it emerges from the financial crisis with cheaper energy and lower relative labour costs. Geopolitical factors, such as Russia’s intervention in Ukraine, the conflicts in Iraq and Syria, and China’s maritime territorial confrontations with its neighbours, may find some type of resolution or risk deteriorating dramatically.
Against this uncertain external background, Candriam favours a focus on cross-market domestic themes, such as taking an overweight position in stocks related to the growth of online commerce, highlighted by the successful stock market listing of China’s Alibaba in the largest IPO in history. With online platforms projected to account for 40% of total Chinese retail sales, there are other opportunities in this sector such as Tencent China, which together with Alibaba and Baidu is one of the leading internet and mobile services providers offering gaming, social networks, e-commerce and financial services.
Asian component makers for Apple also fit into this category. The production of the company’s new iPhone 6 smart phone will boost Taiwan’s GDP by 40 basis points and add 1% a month to Chinese export growth in 2014, according to estimates from Bank of America Merrill Lynch. One of these firms, Taiwan Semiconductor, is the largest holding in Cadriam’s Global Emerging Markets Fund.
While state-linked firms in emerging market sectors such as energy, telecommunications and financials have tended to underperform over the past few years, there may be an impetus for greater efficiency, competitiveness and profitability from regulatory reforms in China and the election of pro-reform leaders in India and Indonesia.
Investors in search of yield have no other choice but to strongly diversify towards the risky asset classes. And what better place for EM bonds than a diversified bond portfolio? Diversify or else! The same applies to investors seeking to invest in EM equities. Candriam, reasonably positive given the valuation and bottoming-out of economic figures, remains cautious in light of the geopolitical risks and possible impact of an interest-rate hike in the US. Although the emerging markets should be included in a diversified long-term portfolio, dispersion is a must!
Accessing emerging growth in equities & bonds
Candriam’s expertise in Emerging Markets spans nearly two decades:
Jan Boudewijns is head of Emerging Market Equity Management at Candriam Investors Group