The Point

Emerging markets: Look past commodity exports to countries with strong domestic demand

Emerging markets investors often focus on commodity-intensive countries – many of which rely on China as one of the world’s top importers.

That may not be an attractive angle right now due to China’s weaker economy.

But it doesn’t mean there isn’t opportunity in the EM space, says Pendal PM James Syme.

Look past commodity export data to identify strong domestic demand stories, says James.

He points to Latin America, where GDP growth and equity market returns are traditionally correlated with commodity prices – especially metals.

“We’re very positive on the outlook for the domestic economies of Brazil and Mexico,” says James. “But not because we’ve got a particularly positive view on metals.”

Both countries should see significant interest rate cuts this year and next, further stimulating what is already quite robust domestic demand.

Capital inflows and caipirinhas: Brazil’s sunny outlook

Brazil’s central bank, Banco Central do Brasil, was one of the first global monetary authorities to start lifting interest rates.

It was tough medicine but now the top-ten economy is reaping rewards earlier than its peers, says James Syme, who co-manages Pendal Global Emerging Markets Opportunities fund.

“In emerging markets, typically everything goes wrong, or everything goes right.

“If things go right, you typically get capital inflows, a stronger currency, a better inflation outlook, the prospect for yields to fall, equities going up along with economic growth – and an easing of any political stresses.

“We think that’s where Brazil is now.

“We are also seeing broadly similar patterns in India, Indonesia and Mexico.

“Long, deep down-swings tend to be followed by long upswings – and that’s broadly what we expect will happen with these economies.”

Emerging markets aren’t so different to us – but you’ve got to pick the right ones

There’s a common misconception that emerging markets countries are dysfunctional, war-torn or burdened with significant health or security issues.

“But they’re not that different from us,” says James Syme, who co-manages Pendal Emerging Markets Opportunities fund.

“The main emerging market benchmark has 24 countries in Latin America, eastern and southern Europe, Africa and Asia.

“Generally they are well-run democracies or stable non-democracies with happy, successful economies and large and growing middle classes.”

That misperception presents an opportunity, says James – as long as investors can choose the right countries.

James and his team are now investing in eight EM countries including Brazil, Mexico and Indonesia.

EMs can help diversify risk in global equities portfolios, says James.

Emerging markets: take care when choosing Asian tech stocks right now

July was a strong month for emerging market equities, with the MSCI EM index returning 6.2%.

Not surprisingly, the strongest gains were in the tech sector — especially stocks with exposure to electric vehicles or artificial intelligence.

While these upward moves could continue, Pendal’s EM team sees “multiple signs that there may be excessive optimism in some of these stocks”.

For example, in Korea, EV and battery stocks represented nearly half of stock market turnover on some days in July, driven by retail investor leverage rising to a record 10 trillion South Korean won.

Chinese EV maker XPeng rose 74% in July, despite expectations it will lose $1.2 billion on $4.5 billion in sales. Meanwhile, some high-quality, large-caps with proven track records and technologies were laggards.

“Some parts of the EM equity space look particularly inefficient right now,” says the team.

Emerging markets: Stimulus unlikely but China opportunities remain

China is struggling with a slowing economy – leaving markets searching for signs of stimulus from Beijing.

Despite some recent market excitement, a quick stimulus package is unlikely, says Paul Wimborne, co-manager of Pendal Global Emerging Markets Opportunities fund.

“We think the key priority for the Chinese government remains building long-term economic and financial system resilience and growth hasn’t yet fallen to the levels that would lead them to aggressively stimulate.

“We think they will continue to push through mini stimulus measures in certain areas where they would like to encourage growth — but we don’t think they’re at a point where we’ll get a big stimulus plan.”

Still, there are opportunities to be found for investors.

“There are parts of the economy we are happy to get exposure to — and parts that we would like to avoid,” says Paul.

Emerging Markets: What’s driving Indonesia’s resurgence

Indonesia’s economic outlook has been attracting the attention of investors recently.

Why so?

Pendal’s Paul Wimborne says an improved trade balance on strong exports of commodities like palm oil, coal and nickel is paving the way for a resurgence in domestic demand.

“Indonesia is at that sweet spot in the cycle where the export side of its economy is doing well, the currency has the potential to go stronger, and domestic demand – which has been subdued for 10 years – looks like it could pick up.”

South-east Asia’s biggest economy is also benefiting from a government push to encourage more manufacturing and reform labour markets, says Paul, who co-manages Pendal Global Emerging Markets Opportunities fund.

Paul’s preferred exposure to Indonesia is via companies that benefit from rising domestic demand, such as banks, retailers and auto dealers.