Fine-Tuned Emerging Markets Investing

Throughout 2016 and 2017, the emerging markets staged an impressive rally. The MSCI Emerging Markets Index surged more than 60%. But since hitting a peak in late January, the index has slid roughly 10%. A rebound in the dollar, which always creates an immediate headwind for emerging market stocks and bonds, is the key culprit. An increase in global trade tensions and an upward move in interest rates have brought further pressure.

But those near-term headwinds are obscuring a much more powerful dynamic in place for EM countries: robust GDP growth. The global economy remains firmly ensconced in a synchronized recovery and is poised to grow 3.9% this year, according to the International Monetary Fund. Emerging markets are expected to expand by a more robust 4.9% in 2018, and that figure surges to 6.5% for markets in Asia.

“This is the ideal global environment for EM equities to perform well,” says Gerardo Rodriguez, portfolio manager of the emerging markets group at BlackRock. “These economies are at a much earlier stage of the growth cycle than developed markets.”

Ed Kerschner, chief portfolio strategist at Columbia Threadneedle, suggests there is a direct relationship between relative GDP growth rates and emerging market performance. The GDP growth in these countries began to accelerate faster than developed markets in 2016, when their GDP was 2.7 percentage points ahead, the first increase in the GDP growth rate differential since 2011.

“And the differential should remain in place in coming years,” says Kerschner, citing IMF forecasts. He cites a still-large gap in productivity rates as a key factor in further strong growth.

For example, the output per worker in developed markets now exceeds $100,000 per year, while it’s less than $20,000 per year in the emerging countries. “There is so much more room for emerging markets to boost productivity,” Kerschner says.

As productivity and incomes rise, consumers in these countries have become a greater force in their local economies. Earnings for firms in the Dow Jones Emerging Markets Consumer Titans 30 Index, for example, are poised to rise 43% in 2018 (and another 20% in 2019).

Kerschner and his team are especially bullish these days on India, one of the world’s most populous countries. The economy there is on pace to expand 7.3% this year, and at a similar pace in 2019, according to Fitch Ratings, with much of that growth coming from consumer goods production. That should help deliver a boost to the Columbia India Consumer ETF (INCO).

Kerschner also notes that heavy spending on infrastructure is lowering the cost of doing business in India. “A new highway between Mumbai and Delhi,” he says, “will cut transit times for goods from 13 to 14 days to just 16 hours.” The Columbia India Infrastructure ETF (INXX) is one way to glean exposure to this productivity booster.