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Emerging markets: Countries likely to weather the storm

Declines in emerging market stocks offer the potential for strong gains once the US rate rise cycle peaks, argues Pendal’s JAMES SYME

DECLINES in emerging market stocks over 2022 offer the potential for strong gains once the US Federal Reserve’s rate rise cycle peaks, says Pendal’s James Syme.

Emerging markets are down from their 2021 peak as tighter US monetary policy drives the US dollar higher, while a weak Chinese economy dampens global growth and geopolitical instability roils growth assets.

But investors that keep an eye out for signs the sell-off is ending could be rewarded with a strong rally, argues Syme, who co-manages Pendal’s Global Emerging Markets Opportunities fund.

“Over the long run, in US dollars, emerging markets equities return a significant premium to the developed markets,” says Syme.

“In pure financial theory terms, that’s the reward for the extra volatility it brings – excess return compensates for increased risk or reduced liquidity. Emerging markets are more volatile, but tend to have a higher reward over the longer run.”

This year’s decline, while significant, is smaller than past sell-offs in emerging markets, says Syme.

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Pendal Global Emerging Markets Opportunities Fund

In the GFC of 2007-08 emerging market stocks fell 60 per cent, while the 1997-98 Asian financial crisis saw EM decline 58pc.

What’s driving Emerging Markets

Three main factors have driven this year’s declines, says Syme.

“The big one has been tightening of global liquidity and the end of quantatitive easing by central banks.

“Related to that is the huge rally in the US dollar. That means other currencies have been weaker, which causes a weaker price performance for EM shares in US dollars, but it’s also reflective of where capital is flowing.

“A strong dollar is an indicator of money flowing out of the rest of the world and into the US and that’s always going to be challenging for emerging markets.”

The second factor is weak Chinese growth amid Beijing’s zero-COVID policy and crackdown on the real estate sector.

“And the last part is a perception of increased global geopolitical risk with the Russia-Ukraine conflict and the colder China-US conflict.

“Those factors create the perception of a riskier environment for international investing in high-risk countries – it’s much easier to own some US treasuries.”

Signs to watch

Investors are watching for signs these three factors may be easing.

“What’s it going to take to end the sell-off and make EM equity attractive as an asset class again?

“One thing would be a change in direction from the US Federal Reserve and a weaker dollar.”

Faltering rallies in recent weeks indicate markets have been looking for that change in direction from the Fed and any suggestion the US economy is softening.

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“We have certainly seen in other developed markets that central banks are starting to move away from tightening – we had a super-dovish quarter point hike from the RBA and emergency bond-buying from the Bank of England.”

An improvement in China’s economy could also mark the turning point for emerging markets.

“We’ve seen signs of shifts in China – credit growth is improving, and we’ve seen corporate borrowing starting to pick up.”

Ending the zero-COVID policy would also be a good sign.

“I don’t think that’s likely to come as a single announcement. But they are letting the Beijing marathon go ahead with 30,000 runners – that’s an interesting step forward.”

And finally, any signs of a change in the Russia-Ukraine war would be a potential positive.

EM countries to watch

When things turn around, investors should stick with the markets that have best weathered the downturn.

These include Latin America, South Africa, Southeast Asia and India, says Syme.

“Right now, there are parts of the asset class that are doing OK.

“The things you’d want to own when we get to the turn are the ones already winning.”


About James Syme and Pendal Global Emerging Markets Opportunities Fund

James Syme is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with Paul Wimborne.

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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here


This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at October 17, 2022. PFSL is the responsible entity and issuer of units in the Pendal Global Emerging Markets Opportunities Fund (Fund) ARSN: 159 605 811. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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