Emerging Markets - The Investment Case
Often misunderstood by those of us living in the developed world, emerging markets (EM) represent some of the fastest growing economies on the planet, with younger populations and expanding middle classes set to boost output significantly relative to developed economies. EM countries now contribute over 50% of global growth and are predicted to contribute over 60% by just 2025.
Let’s first define what an emerging market is, exactly. Of the 200 or so countries in the world, 80% are classified as ‘emerging’, which means that they exhibit some characteristics of more developed markets, but not all. Typically, emerging economies will become more integrated with the global economy over time, resulting in increased liquidity in local equity and debt markets, an increase in foreign direct investment, increased trade volumes (imports and exports), and the development of more robust financial and regulatory institutions, making them more attractive investment markets for foreigners.
The 2021 rebound in global trade and overall demand would usually have meant strong performance in EM stocks, however we’ve seen them lag their developed market peers. This underperformance can in part be attributed to China, which represents a majority of the Emerging Market stock indices.
The government-induced selloff in Chinese stocks following the widespread industry and regulatory crackdowns has left the Chinese stock market at the largest discount to EM Ex-China stocks since 2017. Meanwhile, Chinese economic growth is projected to be 5.3% in 2022, ahead of almost every other region. Only Asia Ex-Japan is predicted to outperform (5.48%), and China itself accounts for a huge portion of that index. The relative price of Chinese stocks therefore looks exceptionally appealing as compared with the broader Emerging Market index.
Importantly though, what is the longer-term investment case for Emerging Market equities? We’ve already mentioned EM GDP growth, but let’s take a look at that in comparison with the rest of the world’s major economies. The United States is projected to grow by 3.9%, the Eurozone by 4.2%, Japan by just 2.6%, and the UK by 5%. Only the UK can claim growth at the same level as emerging markets, however this is projected to fall off heavily the following year once the economy returns to pre-pandemic growth levels, whereas EM countries are forecast to continue to see much higher levels of GDP for the foreseeable future.
Emerging markets are also driving most of the world’s population growth. In total, over 6 billion people (approximately 85% of the world’s population) lives in an emerging market country. The world’s population is expected to increase by an additional 1.6 billion people by 2034, with around 95% of this increase coming from developing economies, signifying the immense growth potential in emerging economies.
The increase in GDP and population over time will lead to the rapid rise of the middle classes, who have more disposable income, spend more money, and tend to be better educated. Going back only as far as 2009, 28% of the global middle-class population came from the Asia-Pacific region. The OECD are projecting this to jump to 66% by just 2030. As if these statistics were not impressive enough, the demographics also look impressive. The percentage of the world’s population under the age of 30 is roughly 50%, of which 90% live in emerging markets.
With the above in mind, it is no surprise that forward earnings for Emerging Markets are currently higher than that for their developed market peers. Equity returns, however, have not yet priced this in, with emerging market stocks having underperformed so far this year. The collapse in 2020 earnings and the resultant low base will likely continue to drive above-trend earnings growth.
At A&J we believe in the long-term growth of emerging markets. The recent selloff in Chinese equities looks overdone and the growth prospects stay very strong, along with extremely attractive valuations for EM assets, which look historically undervalued and particularly attractive given the higher valuations in parts of the developed world.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 2nd December 2021, and are subject to change.
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