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

Economic weakness in China is affecting emerging markets commodity exporters. That means the key to success is looking instead for domestic growth stories, argues Pendal’s JAMES SYME

• China’s weakness affects EM exports
• Focus instead on domestic growth
• Find out about Pendal Global Emerging Markets Opportunities fund
• Watch a recent Emerging Markets overview webinar with James Syme

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 instead for domestic growth stories that do not depend on exporting to China, argues Syme, who co-manages Pendal Global Emerging Markets Opportunities Fund.

“It’s been very good for the portfolio having the overweight positions in Mexico and Brazil — but we’re cautious on metals, cautious on China, and cautious on Latin American commodity stocks,” says Syme.

Why domestic demand matters in emerging markets

Emerging markets naturally go through business cycles where growth leads to inflation and pressure on the trade balance, which eventually leads to higher interest rates and a downturn, says Syme.

“Then eventually at some point inflation is very low, there’s loads of capacity in the economy, and the economy naturally grows. That’s the cycle that happening now in emerging markets.

“It tends to be boosted by what happens with global financial conditions and the US dollar. One of the big patterns we see at the moment is that after a decade of a strong US dollar, we may now be seeing a weaker dollar.

“That really opens the way for strong domestic growth booms in some of these emerging markets.”

Opportunity in Latin America

Some of the markets best-placed to benefit from this change are found in Latin America, argues Syme.

Brazil and Mexico should see significant interest rate cuts over the second half of 2023 and into 2024, further stimulating what is already quite robust domestic demand, he says.

“We’re very positive on Brazil and Mexico. They’re two of the largest overweights in the portfolio.”

Typically, Latin American GDP growth and equity market returns are highly correlated with commodity prices — especially metals.

Latin America is a large producer of oil, with Brazil, Colombia and Mexico all being major producers. It is also a big exporter of soft commodities which are filling supply gaps created by the Russia-Ukraine conflict.

But it is the metals part of the commodity cycle that tends to correlate with growth most strongly, says Syme.

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“We’re very positive on the outlook for the domestic economies of Brazil and Mexico, but this is not because we’ve got a particularly positive view on metals.

“Although there are some significant supply constraints, particularly around copper, the world’s largest demand source for industrial metals continues to be China, the Chinese economy looks very weak and within the Chinese economy, it’s the most commodity intensive sectors that look the weakest.

“So, we have no copper, we have no Latin American gold miners, we have no Latin American iron ore miners. Generally, our exposure to the commodity complex in Latin America is very low.”

Instead, emerging markets portfolios need to be positioned to capture the beneficiaries of domestic growth, says Syme.

Leading opportunities include banks and financial stocks, alcohol producers and brewers, domestic airlines, fast food and building materials like cement, he says.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

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