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In their recent post, Surveying the EM debt landscape amid COVID-19, my colleagues Jim Valone and Kevin Murphy — both seasoned emerging markets (EM) debt portfolio managers — discuss how they’re navigating today’s hazardous terrain, drawing on their many years of investing in those markets. While EM equity is, of course, a distinctly different asset class from EM debt, I was nonetheless struck by some of the similarities between their approach to the current crisis environment and my own.
As longtime EM investors, Jim, Kevin, and I are no strangers to periodic episodes of intense market volatility. Our experience has enabled us to use lessons we’ve learned from past crises as guideposts for today’s markets. At the same time, we all recognize how unique the COVID-19 pandemic is, including the wide range of potential scenarios associated with it.
If your EM allocation includes both debt and equities, I encourage you to read Jim’s and Kevin’s post as well as mine. With that said, here are my high-level thoughts at this time.
Coping with unpredictable shocks
Having managed money since the late 1990s, I have witnessed up close the Asian market crisis, the bursting of the dot-com bubble, the global financial crisis (GFC), and now COVID-19. I have grown accustomed to seeing a severe bout of market volatility plague EM assets roughly every 10 years or so. In terms of what I’m “borrowing” from previous crises, I have dusted off the credit-crunch playbook I relied on during the GFC.
As was the case then, many of today’s companies are potentially facing enormous financial troubles — and will probably continue to do so in the period ahead. Although these problems obviously originated from a different cause than we saw in 2008 – 2009, I suspect the outcomes for many companies will be more or less the same from a financial and balance-sheet perspective.
What’s different about COVID-19?
Compared to other periods of extreme market volatility, COVID-19 is unique in several ways:
- It was completely unexpected — a true “black swan” event — and took hold very swiftly. Usually, you can see some “writing on the wall,” so to speak, that a crisis may be in the offing, but there was no such warning in this instance.
- There are still so many unknowns. When will COVID-19 be brought under control? When will the lockdowns end? How deep will the global recession be? The level of uncertainty gripping markets is unparalleled.
- Unlike some landmark events, such as the GFC and the dot-com bubble, this particular shock did not result from financial or market excesses, but rather from an unforeseen global health crisis.
- The policy tools being used to mitigate the economic impact — an extraordinary combination of fiscal and monetary measures — are unprecedented, as is the timing of the crisis in that it occurred shortly after a period of massive quantitative easing globally.
What about the China factor?
Regardless of its role in individual investor portfolios, China casts a large shadow over the EM equity landscape due to its size and prominence on the global stage. What happens with China, for better or worse, will have varying degrees of implications for other EM economies and asset prices.
As of this writing, the market seems to “think” China is ahead of the curve with regard to curbing COVID-19, but we don’t know this to be true. For starters, only Wuhan had a real “wave-one” outbreak; other cities and regions could still be vulnerable. In addition, transparency into conditions on the ground in China has diminished lately, exacerbated by a travel ban preventing anyone from going there for a first-hand view. That is frustrating for hands-on managers like myself.
Bottom line: It is still too early to say what the outcome will be in China, which only adds to the general sense of uncertainty around COVID-19.
What should EM equity investors do?
From an investment standpoint, investing in EM equity amid such uncertainty is difficult, in part because of the wide disparities in resilience among different EM countries. For example, I believe South Korea, China, and Taiwan have the financial and organizational wherewithal to withstand the health crisis, whereas Indonesia, Brazil, India, and South Africa may not.
More broadly, the situation seems to be enlarging the gulf between the “haves” and “have-nots.” (By “haves,” I mean countries that have stronger health care and communication infrastructures, along with better balance sheets and more diversified economies.) Will the IMF step in to help the have-nots? Will there be social unrest in some countries? Will the haves be knocked down in 10 – 15 years?
These are just some of the questions I’m asking as I continually refine my crisis playbook to meet today’s challenges. One thing is certain in my mind, though: EM equity investors must have the conviction to endure ongoing volatility and should always be on the lookout for potential opportunities. I believe markets like today’s favor the disciplined, discerning, and well prepared.