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Emerging Markets: Is it time to invest in China again?

Is it time to think about investing in China again?

The world’s second-biggest economy remains in the strictures of Covid-19, as much of the rest of the world emerges and battles with high inflation and interest rates.

But in recent weeks there have been signs that things might be turning economically, says James Syme, who co-manages Pendal Global Emerging Markets Opportunities fund.

“To the end of April there was a real sense of doom and gloom around the Chinese economy and assets.

“But what we saw in the May data was clear evidence that some parts of the Chinese economy are doing better.

“I think we need to see more evidence of a fully-fledged recovery. But we are starting to see some evidence of change.

“We are not at the point where you look at the data and say you need to be overweight China, with a highly cyclical portfolio.

“But the things you want to see are starting to emerge, and that’s a shift.”

Emerging Markets: where to find growth in a volatile world

The sometimes-overlooked markets of Latin America are a bright spot in a world worried about inflation, interest rates and war, says Pendal’s James Syme.

“In the first four months of the year, when global EMs were down 12 per cent, Latin American stock markets rose 11 per cent,” James points out.

“And it’s more than just a market move — the underlying fundamentals are looking pretty good.”

Latin America often flies under the radar, partly because its commodity-exposed economies are subject to boom-and-bust cycles that can leave investors vulnerable to swift capital outflows.

But in the face of global uncertainty economies like Brazil and Mexico are doing well.

“We’ve seen GDP growth expectations revised upwards as economic data comes in relatively strongly,” says James, who co-manages Pendal Global Emerging Markets Opportunities fund.

“While valuation alone is not an investment case, most of MSCI LatAm looks pretty reasonably valued in a world where a lot of assets don’t.”

Emerging markets look well placed to weather hike cycle

As the US Fed lifts rates, conventional wisdom says EM economies must keep pace to avoid capital outflows, putting a dampener on their economies.

But this time might be different, says Pendal’s James Syme.

“Our view is that EMs have been hiking hard for some time now — and it actually looks like it’s the Fed that is significantly behind the curve.”

For example, Brazil’s central bank has raised policy interest rates nine times since the first post-pandemic hike in March 2021.

“The implication is that if the Fed has to do 400 basis points in hikes, that doesn’t mean Brazil is going to have to.” The story is similar in South Africa and Mexico, says James.

There’s still a question as to why the Fed is moving more slowly than emerging markets.

“Maybe the Fed is right — maybe there’s much more deflation coming than we can see in trailing data.

“But if that’s the case, we could be getting to the top of EM interest rate cycles. If that’s true, maybe we can start cutting rates again.”

How Emerging Markets investors should approach China now

China’s economy grew at a better-than-expected 4.8% annual rate in the first quarter, despite pandemic lockdowns and tighter regulation on property developers.

But Pendal’s James Syme says a more telling figure may be the recent Purchasing Managers Index — a monthly survey of business activity which shows activity falling to its lowest levels since the height of the pandemic.

“We can only focus on the data and the PMI is a powerful guide to how problematic things are in China,” says James, who co-manages Pendal Global Emerging Markets Opportunities Fund.

Market nerves about China’s outlook mean some of its highest-profile and fastest-growing companies are trading at lower prices than they have for years.

But “cheapness alone is not a driver”, says James. “You need signs of positive economic or political direction.”

Investors should wait to see Beijing’s policy response to the slowdown before their next move, says James.

What the Russia-Ukraine crisis means for Emerging Markets investors

The Russian economy has been performing strongly, but the outlook is now uncertain as global sanctions bite.

We asked Pendal’s James Syme about the implications for EM investors.

“The geo-political risk is intense – possibly the highest of any EM in the modern history of the asset class,” says James.

“Recently the Russian economy has been benefiting significantly from current demand levels and prices for major commodities. The equity market is incredibly cheap on all measures.

“We recognise the intense political risk at the current time and the chance that sanctions mean we will not be given the time to see valuations move to reflect economic fundamentals.

“But we believe that, as index-relative investors, it is risky to not have careful, scaled, diversified exposure to Russia, given valuations and fundamentals.

“An improvement in the political environment could lead to a very significant move in Russian assets, as we have seen in previous recoveries.

Steve Campbell: RBA passes rate cut surprise

Steve Campbell: RBA ‘well-positioned’ to ease rates more aggressively

Monetary policy settings remain restrictive in Australia even after two rates cuts this year, says Pendal’s head of cash strategies Steve Campbell.

Last week the Reserve Bank cut 25 basis points to 3.85%.

A pause in US tariffs and a plethora of other headlines saw the case for a larger cut diminished, says Steve.

“Domestically the RBA remains comfortable with the inflation outlook and where policy settings are at,” he says.

“There are signs that the rate cut earlier this year is helping households, though the majority of the cut is being saved – not spent.

“We maintain the view that two more cuts are forthcoming, likely around the quarterly cycle in August and November.”

Meanwhile bonds continue to offer good defensive value in this environment, Steve says.

“And uncertainty surrounding international events ensures plenty of opportunity for active managers.”

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