“Latin American markets have had a strong start to 2022, and a large reason for that is that most of Latin America is a very large commodity exporter,” Gupta says. “As the MSCI Emerging Markets Index declined strongly in the first quarter of 2022, Latin American equities performed very well.”
China, on the other hand, is being squeezed by oil prices.
Global Growth Trends
Global growth is slowing, but the slowdown is uneven. Some areas will continue to grow faster than others, with China being the elephant in the room. China’s growth, which had already been decelerating, has now been frozen by its zero-Covid policies, including the lockdown of many cities.
“We’re coming off a period of high regulation in China, and then you have the zero-Covid policies in effect,” says David Semple, a portfolio manager with Van Eck. “Consumer sentiment there was relatively weak anyway, and we haven’t seen the policies have an impact. There’s a lot of work to be done in terms of engendering a better environment for consumer activities.”
Elsewhere, the growth picture is more positive. India, though it’s an importer of fuel, continues to expand its economy as its middle class flourishes. Since the country is a net exporter of wheat, its economy may show some resilience against global inflation, says Semple, but he adds that India is also usually overvalued as an investment.
In addition to a headwind for many types of investments, inflation is also a symptom of growth, Patterson says.
“Inflationary environments don’t always mean the same thing in different regions,” he says. “Where growth is rising, inflation also tends to increase as a result of demand rising, and that’s a positive for emerging markets.”
Even in China, over time, growth should rebound as the country emerges from lockdowns and feels the positive effects of monetary stimulus. Overall, growth within emerging markets should be stronger than that of developed markets, but it doesn’t necessarily make them the best place to allocate assets.
Valuations
Valuations have been a major factor for those expecting emerging market outperformance in the past, and that remains the case today, even in fixed income.
“We’re roughly trading at medium-term averages in terms of credit spreads, and as we talk it is getting wider and steepening—so at the moment there are pockets of value in emerging markets,” says Ed al-Hussainy, a senior analyst with Columbia Threadneedle. “A lot of institutional-grade, high-quality emerging market debt has really cheapened this year, but the same is true in developed market credit.”
In equities, there may be even better opportunity in some developed markets outside the U.S. Valuations in these markets took a particularly hard hit after Russia invaded Ukraine.
“There have been times where emerging markets have been cheaper,” says Semple. “When you look at their price-to-book versus developed markets and their forward multiple, we’re talking about 15-plus-year lows for the entire developed market asset class. Still, the cash-flow return on equity for emerging markets remains above that of developed markets.”
Factor Performance And Indexing
Besides their attractive valuations, emerging market securities could also benefit from their value tilt. Global investment markets have tilted sharply to favor value since the initial drawdown caused by the onset of Covid-19 in the West.
“In emerging markets, we’ve seen value outperforming growth for a considerable period of time, but it’s clearly been the opposite in developed markets, where until recently growth has outperformed value,” says Gupta. Because emerging markets are naturally weighted toward value sectors like commodities and financials, any global movement to favor value also favors emerging markets.
But emerging markets and global value indexes may not be the best places to capture this performance. The returns tend to be very different depending on the country and region.
After all, the category includes mature and modern markets like Taiwan and South Korea, heavyweights like China and India, distressed markets like Argentina and Zambia, and true frontier markets like Kazakhstan and Egypt.
“As an active manager, I’m biased, but I wouldn’t invest in emerging markets passively, because our indexes are a zoo,” says Hussainy. “No other indexes are this broad in terms of quality.”