As we continue through the long winter of the pandemic, we believe the present environment of abundant financial liquidity is likely to provide a promising backdrop for emerging markets (EM) returns in 2021. Beyond that, we think that structural change sweeping several North Asian markets may shape the next decade of EM opportunity.
And that strength may continue. Consensus forecasts for EM GDP growth in 2021 have recently been upgraded and now stand above 7.5%, with EM earnings growth forecast at more than 30% on a year-over-year basis.1 Moreover, it remains clear to us that monetary and fiscal policy in North America, Europe, and Japan will remain supportive for EM economic growth.
Short-term headwinds emerge
While we maintain a positive outlook for EM, a couple headwinds appear to have strengthened in early 2021: compounding economic uncertainty relative to the global course of the coronavirus pandemic and a modest tightening in China’s monetary policy.
From our perspective, while we’re likely to see the global economy normalize over the course of the year, it’s now far from clear that there will be synchronous recoveries across EM as well as developed markets. Like all viruses, COVID-19 isn’t static but transforms as it spreads, and the world is apprehensively watching this unfold in real time. Add to that the uneven response we’ve seen from many countries’ vaccination programs, and ongoing lockdowns across several important economies. We believe this pandemic-driven unpredictability is likely to persist for at least the next six months.
As for China, conditions in the world’s second-largest economy have recently improved, and its 2.3% real GDP growth rate in 20202 demonstrates its resilient growth trajectory. While China’s economic conditions appear to us to be better than those in many other parts of the world, accommodative monetary conditions may be tightening in the near term. In fact, the People’s Bank of China signaled a desire to slow things down by subtly applying the brakes on monetary and credit policy.3 The Chinese Communist Party’s scheduled March 2021 ratification of its 14th five-year economic plan is a key agenda item in a busy year for Chinese policymakers, and we expect that they may ultimately decide to keep some monetary and fiscal firepower in reserve rather than implement further stimulus measures now.
Pandemic-driven technological change may trump short-term challenges
While China’s immediate stimulus outlook and other potential headwinds could become sources of short-term volatility for EM equities, in the medium to long term we continue to see great potential in a select group of firms within specific industries that have shown remarkable resilience amid the pandemic and even managed to accelerate their growth. A number of these standout companies are found today in industries that were already experiencing strong growth before the pandemic, such as e-commerce, electronic payments, cloud computing services, data centers, online education, and online healthcare diagnostics.
In late 2020, the relative performance of some of these companies fell back as investors rotated into other stocks expected to benefit more significantly over the short term as economies gradually reopened. We viewed this cyclical shift as a natural reaction to the unwinding of valuation levels that we believed had become extended in pockets of the EM equity universe. Again, however, we see this as a temporary development against a backdrop of more fundamental change.
A long runway for new economy stocks as growth catalysts
Whatever dynamics play out over the short term, these new economy stocks reflect long-term secular trends that we believe will continue to drive EM. The pandemic has served to accelerate the adoption of new enabling technologies and processes across many of these industries that will have a long-lasting positive impact on the growth prospects for those companies that have been first movers.
In fact, in January 2021, we saw some sectors with abundant new economy stocks—communication services, consumer discretionary, and information technology—reassert themselves from a performance perspective. Three North Asian markets—China, South Korea, and Taiwan—that are home to many of these companies also exhibited relative strength. In Taiwan specifically, vibrant global demand for products relating to 5G communications, the Internet of Things, and autonomous driving has been a catalyst.
Although some commentators may be tolling the bell for new economy stocks in favor of old-fashioned deep-value cyclical stocks, we believe that well-managed new economy EM companies with strong business models will continue to provide strong long-term investment opportunities. The challenge is to assess, for each industry, what the new normal looks like as the pandemic shifts. By our estimation, over a quarter of expected EM earnings growth will be driven in the near term by stocks in industries that are beneficiaries of the work-from-home shift such as semiconductors, technology hardware, e-commerce, and media and entertainment. We know that these trends were in existence before the pandemic and have been amplified by it, and we believe they’re likely to shape the next decade of EM investment opportunity.
1 Institutional Brokers' Estimate System, as of January 31, 2021. 2 Statista.com, as of January 21, 2021. 3 “China Credit Growth Slows as Central Bank Normalizes Policy,” Bloomberg News, January 12, 2021.