Emerging markets may re-emerge
Emerging markets (EM) have been defined as places where the whims of policymakers may matter at least as much as the rising and falling of the business cycle for investors. Investing in them can involve greater political, social, economic, and regulatory risks and uncertainties than more developed markets. These factors can make emerging market stocks more volatile and potentially less liquid than stocks from more developed markets. But because they have not historically moved in lockstep with developed markets, they can help diversify investors’ portfolios. Diversification and asset allocation do not ensure a profit or guarantee against loss.
EM tailwinds: valuations, growth, a weakening dollar
Jurrien Timmer, head of Global Macro at Fidelity believes 2021 could be a good time for EM stocks, partly because their prices are attractive as the year begins. “Stocks in developing countries trade at valuations that are only 0.61x the price-to-earnings ratio of the US, the lowest in almost 20 years,” he says.
Economic fundamentals may also favor EMs in 2021. China and many of the emerging market economies which are driven by trade with China have returned to positive growth led by a recovery in manufacturing and increased government stimulus spending. China’s path out of lockdown suggests that recovery for other emerging market economies is also likely to continue.
The strength of the US dollar is also important for emerging markets. When the dollar has been strong and the commodities that many EMs export have been cheap, they have suffered. When the dollar has been weak, though, EMs have historically thrived—and there are indications that the value of the dollar may stay relatively low in 2021. This combination of the weak dollar, historically low stock valuations, and a global economic recovery as the COVID-19 pandemic abates could make 2021 a year in which EM stocks thrive.
China leading the way
While US stock indexes have delivered higher returns than international indexes over the past decade, the best performing individual stocks have come from China. In 2021, China is simultaneously remaking its economy to emphasize consumer spending over export-oriented manufacturing, recovering from a pandemic, and exchanging its emerging market status for the cachet of a rising global power.
As the first victim of the no-longer-novel coronavirus, China is the major economy that has traveled farthest on the long march to recovery. Fidelity’s director of research Lisa Emsbo-Mattingly follows the Chinese economy closely. “They got COVID first and got out of it first,” she says. 2021 could be a year of ‘revenge spending’ where pent-up consumer demand drives faster economic growth.”
If vengeful consumption takes off in China in 2021, it could join other tailwinds propelling the economy. John Dance, portfolio manager of Fidelity® Emerging Markets Fund (FEMKX), sees both rising consumption and changing government policy creating opportunity for investors. He says long-term prospects for corporate earnings growth that fuels rising stocks is being driven by discretionary spending by a burgeoning consumer class.
Dance says Chinese stocks are also benefitting from the government’s increasing efforts to spur the growth of domestic companies that provide high-value services such as health care. The health care industry is at the center of the government’s “Made in China” 2025 strategic plan, which seeks to develop home-grown intellectual property in industries that have historically been dominated by western firms.
A variegated landscape
Investors should keep in mind that the emerging markets category contains a wide variety of companies operating in very dissimilar countries. The countries that are grouped within the same emerging market indexes 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 complex and highly diversified economies, sophisticated financial markets, and relatively transparent and effective 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 meddling in the management of companies.
This makes both careful security selection by experienced managers and diversification within portfolios important for spotting opportunity while avoiding undue risk. It also means opportunities may take unexpected forms. Latin America is not widely recognized as a hotbed of technology innovation, but Will Pruett, manager of Fidelity® Latin America Fund (FLATX), thinks that could change in coming years and create opportunity for investors. “No one should ignore the home-grown innovation taking place related to cloud computing, web services, and digital payments in Latin America—all of which I see as growth areas,” he says.
Pruett says Latin America’s tech economy—like other EMs—has benefited from an emerging middle class, high smartphone use, savvy entrepreneurs, available capital for investment, central bank policies that push for innovation, and consumers who embrace new products and services.
Sammy Simnegar, portfolio manager of Fidelity® International Capital Appreciation Fund (FIVFX) also says prospective investors should pay attention to the variegated nature of EMs. 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 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.