Portfolio manager explains what the ongoing invasion means for specific countries and sectors
Even before Russia’s decision to wage war on Ukraine, investors had generally been painting emerging markets with a brush of pessimism. But as the conflict deepened, there’s been a slight shift in the view on developing markets, particularly when it comes to EM equities.
“From a Canadian perspective, ‘challenged’ is probably a good general description,” says Michael Greenberg, SVP and portfolio manager at Franklin Templeton Investment Solutions. “If you look at equity performance, emerging markets, along with Europe, have been the hardest-hit from a market performance standpoint.”
According to Greenberg, there’s definitely been some negative sentiment from the standpoint of equity performance following the invasion. But he also pointed out that the term “emerging markets” is still used as a catch-all term to encompass countries that are very unique from one another. In other words, even though many people include an EM product in their portfolio, they may not appreciate the massive differences that may lie under the hood.
“If you look at some of the emerging markets in Eastern Europe, given they're much more directly impacted by the Russia-Ukraine war, sentiment towards some of those countries is a lot worse versus maybe some Latin American countries that actually benefit from rising commodity and agricultural prices,” Greenberg says.
From a regional perspective, he said Eastern Europe has taken some residual damage from the conflict as it has the most direct trade linkages. The hit to European growth on both developed and developing-market fronts, he adds, is affecting emerging markets as a whole. Beyond that, Europe is reeling from supply chain struggles as well as the ongoing refugee crisis.
Beyond the borders of Europe, he says investors may also consider drawing a line between emerging markets that are heavy importers of energy, versus those that are exporters of energy. Heavy energy buyers include places like South Korea, which relies on imports for about 93% of its energy need. India’s 46% might not sound as impactful – until you consider that it has the world’s second-largest national population.
The conflict in Ukraine is also sending food prices higher because of disruptions to the food exports that come from Russia, Ukraine, and Belarus. “If you look at a country like India, 50% of their inflation basket is food. In places like the Philippines, China, and Russia, it's about 30%,” Greenberg says. “Compare that to the U.S., where food is just 8%.”
Looking through a sector lens, he says consumer discretionary names in developing markets may be in for a reckoning. As the rising costs of food and fuel take a larger bite out of the average consumer’s budget, that eats into their ability to spend on non-essentials.
“I think the overarching theme for us is really, when you look at emerging markets in general, it’s a story of an extended period of higher food and energy prices that causes higher inflation,” Greenberg says. “That probably will also force central banks to tighten monetary policy a little bit more, which could make some of those regions a little bit more vulnerable.”
However, Greenberg also highlighted the importance of considering time horizons. Taking the near-term view, he said that his team had been less positive on emerging markets even before the Russian invasion of Ukraine. Major central banks, including the Fed, were widely and correctly anticipated to tighten monetary policy, leading to higher interest rates and a higher US dollar. There’s also the reality of slightly less liquidity globally, which is generally an immediate headwind for emerging markets.
“Couple that with COVID, and maybe lower vaccination rates and possibly less efficient vaccines in some of those regions impacting the reopening of those economies, we felt there was maybe a little bit of a headwind near-term,” he says.
But over the medium to long term, he says they share an outlook of growth over the next five to 10 years. From a secular perspective, he cites the likelihood of growing populations of middle-class families pushing up consumption rates. There’s also the fact that EM equity valuations aren’t at the levels of developed markets, which means some developing markets may be poised to have attractive returns relative to more advanced markets on a longer-term horizon.
“Although there's some reasons to be maybe be a little bit cautious short-term in general, I think as we look at a little bit medium to longer term, we're kind of a little bit more constructive there,” he says.