Before Covid-19, the emerging market economies like China, India, South Korea and Taiwan were seeing an economic surge as tens of millions of people joined the middle class every year. Many economists expected these countries to enjoy another banner year in 2020 as more of their citizens turned into consumers.
The pandemic ripped up that script, and countries like India and Brazil continue to face enormous setbacks and devastating human losses.
As it did everywhere else, the pandemic exposed the huge gaps between have-nots and haves. It also accelerated trends already in motion, such as the desire to avoid stores and shop at home: Consider the yawning gap between those countries in best stead to fight the pandemic, graced with technology companies that allowed them to roar back to economic life.
Think, specifically of Asian countries like South Korea, China and Taiwan, which had those advantages in spades. These countries benefited from strong healthcare infrastructures, mobilized testing and contact tracing, and were already used to life-saving masks. Thus these countries were among the first to navigate the crisis and emerge with their economies in better shape, say portfolio managers.
The crisis upended the tech landscape overseas too, allowing the entrance of new companies and broadening the investment opportunity set. But while tech was the big success story, as the world reopens, consumer cyclicals, materials, energy and commodities have also started to regain their vitality—and those sectors have long been associated with the success of the emerging markets.
John Paul Lech manages the Matthews Emerging Markets Equity Fund, a general EM fund that Matthews Asia launched last year after keeping its focus mostly to Asia before. He notes that vaccination rates in different countries—particularly the infrastructure required to get needles into arms—will likely determine the reopening rates. “If you look at rates of vaccination, you’re upwards of 40% in a place like Chile and in Peru it’s like 2%.”
But all the puzzle pieces have been shaken up. Even if a middle class continues to emerge in these countries, Covid has likely put unstoppable changes in motion. “You go to a hotel in Mexico next year. How many people are needed in that check-in process?” Lech asks. “Has that changed structurally because digitization—or themes like that—were accelerated during Covid?”
Meanwhile, he says, older consumers in these countries who had never bought things online before now might realize they don’t have to wander back into stores. “I’m less worried about the eventual recovery of economies,” Lech says, “and more about how does the next normal potentially differ from what we were accustomed to in pre-Covid times.”
Take India, for example, where Lech has a stock holding in the IT services space. “If you’re able to have most of your workforce at home and you’re really delivering services to a global clientele base, that is a completely different thing than a company that requires a lot of movement and sale of non-essential items. I think India’s recovery, like a lot of different places, is going to be business-model dependent.”
Aash Shah with Summit Global Investments, whose global strategy includes emerging markets companies, says stimulus packages and QE in every central bank have helped all the markets, especially emerging market countries. But he adds that countries like India and Brazil have been the most affected by the virus. India had reported 26 million cases and 291,000 deaths by mid-May, while Brazil had 15.89 million cases and more than 444,000 deaths.
Shah also says that there’s likely a stark amount of undercounting in the deaths in India. “They just don’t have enough testing kits. They don’t have supplies. They don’t have oxygen cylinders. And they don’t have vaccines.” The International Monetary Fund had anticipated a 5.8% economic growth rate in India in 2020, but that recently changed to a 7.7% contraction.
But emerging markets look cheap by United States standards, he says, and that’s a tailwind for these countries, whose companies’ valuation multiples shine by comparison.
In March, Goldman Sachs said that the next-12-months price-to-earnings ratio for emerging markets was an attractive 15.4x, while it was 23.5x for U.S. markets. But the earnings are going to depend on how well countries have handled the crisis.
“Ravaged by the pandemic, 2020 was an exceptional year by any standard, witnessing both the sharpest recession and, in a lot of EM, the strongest recovery on record,” Goldman said in its March report. “Going in to 2021, we argue that much of the heavy lifting would need to be done by earnings per share growth.”
Shah does point to one red flag in emerging markets, however—and that’s food inflation. He notes that the agricultural commodities subsection of the Bloomberg commodities index was up 72% year over year in early May. Rising world food prices hurt in places where people spend a greater proportion of their budget on food, as they do in EM countries. That can cause political turmoil, he says. “Food inflation is going to ravage those households much more than in the Western world. … If you remember in 2010 and 2011, you had the thing called Arab Spring, that was highly coinciding with the food inflation that they say was basically a contributing factor to the discontentment of the population.”
As the world rebuilds, industrials and materials companies should do better in emerging countries, Shah says. That’s especially true as housing market takes off in the U.S. and EM countries can feed the demand for exports like lumber, copper, aluminum and steel.
The financial services sector is tricky and depends on where you play. Chinese financial companies like Ping An and China Life Insurance haven’t taken off, Shah says, because they’re state-owned enterprises, and despite the dividends, you aren’t sure what you are owning. India, on the other hand, is a country where the home mortgage industry is taking off and only 15% of the population is under a mortgage (most people still live in multi-generational homes, he says). Also, the World Bank put the country’s unbanked population at 190 million, and researchers have suggested that half the existing bank accounts are inactive.