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I’m often asked lately: Why are you so bullish on emerging markets (EM) equities these days? What makes the story so compelling, and what’s driving it? Let’s take a look, and while we’re at it, I’ll share my latest thoughts on China’s burgeoning A-share market.
I believe the broad opportunity set in EM equities is particularly attractive today, fueled in part by the unprecedented amount of liquidity in global markets. China’s was the first EM central bank to begin tightening monetary policy. In the US, real interest rates moved unexpectedly higher recently, which has led to some market tension within EMs between prospects for stronger global growth and whether or not higher real rates will persist. Brazil and Russia are also tightening policy amid looming inflationary concerns.
Stronger global economic growth post-COVID-19 appears to be just around the corner as another potential catalyst for EM equities. The US is leading the way right now, with the rest of the world likely to soon follow suit. In fact, if all goes well, I think we may be on the cusp of one of the greatest global economic expansions of our lifetime. EM equities as a group have historically benefited from ample liquidity and robust growth, so I’m quite bullish on the asset class going forward. However, I also expect to see dispersion of returns within the asset class.
In addition, the “currency factor” could provide a tailwind for some EM countries and a headwind for others, creating a potential opportunity across the region. When the USD is relatively weak, US investors’ overseas returns are magnified when converted back to USD. As of this writing, the outlook for the USD is mixed. On the one hand, it’s a “risk-off” currency that may struggle as we enter a more procyclical environment. On the other hand, the USD could strengthen if US interest rates rise further.
I see numerous opportunities across EM equity regions, countries, and sectors. That discussion is beyond the scope of this blog post, so for now, I’d like to just briefly highlight China’s up-and-coming domestic mainland (A-share) stock market in particular.
I believe this market is at an inflection point. With over 3,800 stocks (including some of the world’s fastest-growing companies across investable themes like digitization, consumption, and luxury) listed on the Shanghai and Shenzhen exchanges, China’s onshore market offers plenty of idiosyncratic opportunities for investors seeking risk diversification and potential return enhancement.
However, it’s a market that remains underrepresented in global benchmarks and “under-covered” by the institutional investment community (Figure 1). As of September 2020, China A-share stocks accounted for only 5% of the MSCI Emerging Markets Index — a figure that’s expected to grow to more than 20%. So, the opportunity set will only get bigger over time.
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