Which emerging markets should you be considering now?

It's been a tough year but PM says it's far from a homogenous asset class

Which emerging markets should you be considering now?

While emerging markets have been down about 15 per cent year to date, there remains pockets of opportunities and reasons for optimism, according to one portfolio manager.

“Emerging market stocks have a high degree of sensitivity to global growth and global growth expectation, and it’s certainly been a tough year,” David Kletz, vice-president and portfolio manager with Forstrong Global Asset Management Inc. told Wealth Professional, citing surging inflation, the war in Ukraine, and concerns that central banks will keep increasing interest rates to get inflation under control.

“When you have a scenario where central banks are tightening policy, that generally weighs on the liquidity conditions in global financial markets, which impacts the demand for emerging market assets.”

Kletz noted that, although emerging markets tend to be a high beta type of asset class, their decline is in tune with the broad global equity indices, which are also down about the same amount. He reminded advisors, though, that this is not a homogeneous asset class.

“You have countries with all different types of political and economic profiles," he said. "They get lumped together by some common denominators among them, like the level of development, GDP per capital, and the strength of their financial market institutions, but there are many, many differences,” he said. “The divergence in performance, this year, among EM nations has been quite substantial, even by recent-year standards.”

Kletz said investors can’t trade Russian assets anymore because they’re no longer investable. In Asia, Indonesia did well, but China has had a sharp correction and been down about 20%, and it was “one of the few markets that actually had policy support".

“The Chinese policymakers, both on the monetary and fiscal side, were biased toward stimulating the economy, whereas just about everyone else was going in the opposite direction,” he said. “The lockdowns that China experienced recently, in response to COVID outbreaks, have really put a dampener on that economic momentum and investors’ risk appetite or enthusiasm toward Chinese assets.”

Asia has the biggest index allocation – with China having the greatest impact. But, the region is a commodity importer and Kletz said investor sentiment toward Chinese assets seem to be at all-time lows. Its inflation has remained relatively benign, even though a number of the area’s central banks haven’t been proactive in getting out in front of inflationary pressure, which Forstrong believes may be a disadvantage going forward. Still, he noted that the lockdowns will eventually end, and China will stimulate the monetary and fiscal side, which is critical, given it’s a “key cog” in global growth.

Latin American nations have a less stable political environment and more commodity exports, but he noted that their central banks were very proactive in raising interest rates quickly to keep inflation from spiralling. So, these countries – especially those with a sensitivity to industrial metal exports – have had an incredible run recently. Forstrong has invested in Brazil and Chile, which have been up about 16% on the year. That’s about a 30% outperformance of the broad index, and provides a hedge against inflation. He noted that the Russian war on Ukraine accelerated that trend.

Kletz said the remaining regions – the Gulf nations and Europe – are a small part of the index, but the Gulf countries have also done quite well, given their exposure to oil exports and energy. But,the few Eastern European countries in the emerging markets index – such as Poland, Hungary, and the Czech Republic – have been struggling, not just because they’re bordering Russia, but because they’re also dealing with the ensuing refugee crisis.

Overall, he’s positive, however, because the U.S. consumer is still in relatively good financial health and Chinese lockdowns will eventually end. But he urged advisors to separate the emerging market importers and exporters. The Russian war means the demand for commodities, especially industrial metal, should be well supported by a pivot to renewable energy and reconstruction of electrical grids. So, it’s a good time to stay invested in asset classes exposed to commodity prices in countries such as Brazil, Chile, and Peru, which offer an inflation hedge. Conversely, countries like India, which rely heavily on commodity imports, especially for all their oil needs, will continue to struggle.

While Forstrong is still trying to gauge investor sentiment and risk appetite, Kletz felt “we’re perhaps near the bottom and we could start taking on risk again, and that would be positive for emerging markets".