The hidden potential of emerging markets

Schroders has raised this year's GDP growth forecast for China to 9.2% from 9%. (Image: Studio)

To understand the nuanced macroeconomic dynamics of emerging markets, it is important to look beyond the meager numbers, according to David Rees of Schroders.

Recently, Schroders experts revised their forecasts for this year's global economic growth from 5.2% to 5.9%. However, this projection referred to industrialized countries and took into account only a slight upward correction of estimated production in emerging countries.

According to David Rees, Senior Emerging Markets Economist at Schroders, GDP growth in the emerging markets will approach the level of all other countries in the next 18 months, as has not been the case since the turn of the millennium.

In his view, investing in emerging markets is not just about benefiting from relatively rapid economic growth. He said the chart below shows that growth has historically been an important factor in the relative performance of assets like stocks.

The external vulnerabilities for emerging markets are relatively limited. Rees anticipates hesitant growth in the face of a more restrictive stance by the Fed. "However, looking at emerging markets as a single asset class is misguided. The macroeconomic outlook continues to offer many investment opportunities for investors", said the Schroders expert.

Asia continues to set the tone

In the very short term, Asian manufacturers continue to set the tone, in his view. "In fact, we have raised our GDP growth forecast for China this year from 9% to 9.2%. The prerequisite for this is the reopening of the global economy and thus strong demand for services, but also to a certain extent for goods", says the emerging markets expert.

In China, according to Rees, the first signs of a second, small inventory cycle of the latest manufacturing EMI are already emerging. The hesitant production is possibly already an indication of supply bottlenecks. Noticeably strong demand should support business activity. This is likely to have an impact on other export-dependent markets within Asia, he added. The performance of the markets in the region should benefit from this.

However, the overall picture remains unchanged: "The long-term leading indicators for China's domestic economy have been turning around for some time now. Growth in the real M1 money supply peaked in November of last year, but the credit impulse has been weakening since October. Both of these, with a lag of about nine months, are a good indication of the future direction of growth, implying that China's economic slowdown will begin to emerge in the third quarter", Rees explains.

For cyclical markets such as equities and commodities, it will be more difficult, he said. However, local bond markets, which are increasingly opening up to foreign investors, are likely to offer opportunities. At the beginning of the year, Rees argued that emerging market growth would shift from Asia to other regions. This development is now discernible.

Other emerging market regions are following suit

According to Rees' observation, the Brazilian economy withstood the second wave of infection much better in the first quarter. The significantly more favorable trading conditions should be positive for momentum in the coming months. "As we expected, the performance of local markets has improved in recent months. The short-term outlook is positive, even if the election calendar is a cause for concern", he says.

In the meantime, Mexico's economy has also recovered. The country has so far been one of the laggards among the emerging markets. This positive trend is reflected in the manufacturing sector, he says. The reason: demand from the neighboring U.S., the destination of most Mexican exports, has skyrocketed, he says. The chart below illustrates the historically close correlation between changes in the overall U.S. EMI index – which hit an all-time high in May – and the performance of Mexico's manufacturing sector. This should have a positive impact on the performance of local assets.

Vaccination campaigns and the subsequent reopening of economies are likely to be another theme driving up markets. There is no doubt that the external environment could become more difficult in the coming months. Investors willing to look beyond the headlines, however, are likely to identify investment opportunities.

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