- Emerging market stocks and bonds represent long-term investment opportunities that can help diversify investors' portfolios.
- But volatility may continue, despite a US-China trade deal. And performance is likely to vary across countries and industries.
- Among potential outperformers: India and well-run companies in the industrials, consumer technology and health care industries.
- Careful security and fund selection by professional managers is important.
The trade battle between the US and China that escalated in 2019 caught stocks and bonds from emerging market (EM) nations in the crossfire as investors worried over the global trade environment. Now that the world's 2 largest economies have settled some of their differences and signed a new trade agreement, what's next for EMs who have long depended on the US and China?
While trade tensions between the US and China hurt EMs, the new trade agreement may not benefit EMs as much as might be expected. That's because the growth prospects for many EMs in the present and future don't rely on trade and exports in the way that they did in the past. Many of these countries' economies grew rapidly over the past several decades as global trade expanded and they exported commodities to China and the US. Sammy Simnegar, who has managed Fidelity International Capital Appreciation Fund (FIVFX) since 2008 says, "I think it's wrong to look at emerging markets through the lens of the last cycle when commodity prices were high and the dollar was weak." But while he believes that those days of commodity-driven growth are over, he sees opportunities in some emerging markets for other reasons.
More happening than trade wars
The signing of the new US-China trade agreement will not postpone what Simnegar calls the end of the "commodity supercycle"—a long period of seemingly insatiable demand—largely from China—for raw materials such as oil, iron ore, and copper. That demand was the result of China's relentless drive to build factories, ports, roads, and even entire new cities as it became a global power. Now that China has largely built out its infrastructure and is restructuring its economy toward consumer spending, the double digit annual increases in commodity demand and prices that enriched many EMs are unlikely to resume. Indeed, as Fidelity's Asset Allocation Research Team notes, China's policymakers are now focused on promoting economic stability rather than growth.
Security selection matters
With the "commodity supercycle" at an end, the countries that are grouped within the same emerging market indices may present very different opportunities—and risks—to investors. Some emerging markets have, well, emerged more than others. For example, South Korea and Taiwan's economies, financial markets, and governments today closely resemble those of developed markets. Meanwhile, other EMs, such as South Africa and Brazil, have suffered from corruption and a trend toward politically motivated interference in the management of companies.
Simnegar says prospective investors should pay attention to the variegated nature of EM. He sees the most attractive opportunities in countries such as India that have outgrown their previous roles as exporters and are growing robust consumer economies of their own. "Middle-class growth is fueling myriad long-term opportunities in emerging markets," he says. He notes that India, for example, now boasts a greater number of households with disposable income of more than $10,000 than does Japan. The growth of these domestic consumer markets is a key reason why Fidelity's Asset Allocation Research Team forecasts EMs to grow to comprise about half of global GDP in 20 years, compared with about 40% now and one-quarter 20 years ago.
How and when to invest
Investors who want exposure to the long-term growth potential provided by EM consumers and who expect portfolio diversification from an allocation to EM should consider whether they also want exposure to some of the less attractive assets that are grouped together with the brighter lights within EM indexes. Simnegar says actively managed mutual funds that practice careful security selection and rigorous research may be preferable to passive strategies that reflect the performance of assets whose quality varies widely. When selecting stocks for the EM funds he manages, Simnegar seeks companies with what he calls the "3 Bs," which are barriers to entry, strong brands, and best-in-class management teams. He says that overall, he has found these companies largely in the industrials sector, as well as in consumer technology and health care.
Simnegar also recommends investors avoid trying to "time the market" in expectation that reduced trade tensions will produce gains for EM stocks and bonds. Indeed, investors should also consider that EM market volatility may be unlikely to subside completely after the US and China settle their present dispute. Data from the World Trade Organization suggests that the US-China conflict is only part of a broader reset of trade policy around the world. From 2017 to 2018, WTO member countries imposed 137 new tariffs, taxes, or duties on $588.3 billion worth of global trade, more than 7 times the amount in 2016. Greater trade tension could produce ongoing volatility and vex those who try to time markets rather than simply investing on an ongoing basis for the long term.
Finding emerging market investing ideas
Investors who want emerging market assets for diversification and long-term growth should consider professionally managed mutual funds and ETFs. Fidelity's mutual fund screener can help you find emerging market investment ideas. (Note: These results are illustrative and are not recommendations by Fidelity or the fund managers.)