Never mind the trade wars—look to EMs

For long-term investors, volatility matters less than emerging markets' future prospects.

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Key takeaways

  • Trade wars have raised investors' concerns about emerging markets, but many EMs still represent attractive long-term investment opportunities.
  • Emerging markets' recent growth has been fueled by commodity exports but their future growth will be fueled by consumer demand from their own citizens.
  • Investors should understand that all emerging markets are not created equal, so careful security selection is important.
 

Trade tensions between the US and China have been helping to roil markets since early May when the Trump administration put a 25% tariff on $200 billion worth of Chinese imports and threatened to impose tariffs on an additional $325 billion. Among the assets that have been caught in the crossfire between the world’s 2 largest economies are the stocks of companies from emerging market (EM) nations whose prices have suffered as investors worry over the global trade environment.

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. Now with trade tensions increasing and global economic growth slowing, investors may wonder if EMs’ best days are behind them. Not necessarily, says Sammy Simnegar, who has managed Fidelity International Capital Appreciation Fund (FIVFX), since 2008. "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," he says. 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

Simnegar cautions investors against viewing the current trade dispute as a passing phase during which worrisome headlines may prompt markets to sell off and create buying opportunities in mispriced stocks. Instead, he says investors need to understand the shift toward protectionist trade policies as only 1 challenge facing many EMs.

More significant is what he 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.

Security selection matters

With the "commodity supercycle" at an end, 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 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 meddling 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 that an allocation to EM can offer 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" to take advantage of buying opportunities created by trade turmoil. Indeed, investors should consider that EM market volatility may be unlikely to subside completely even after the US and China settle their present dispute. Data from the World Trade Organization suggest 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

Despite trade-related headwinds and lower commodity prices, Simnegar believes carefully selected emerging market assets can provide diversification and long-term growth in a portfolio. 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.)

Mutual funds holding EM stocks

Fidelity funds
Fidelity International Capital Appreciation Fund (FIVFX)
Fidelity® Emerging Markets Fund (FEMKX)
Fidelity® Emerging Europe, Middle East, Africa (EMEA) Fund (FEMEX)

Other funds
T. Rowe Price Emerging Markets Discovery Stock Fund (PRIJX)
JPMorgan Emerging Markets Equity Fund Class A (JFAMX)
Invesco Emerging Markets Select Equity Fund Class A (IEMAX)

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