Emerging markets are keeping investors edgy. But there’s no need to wait for recovery signs to strengthen before making a move. The time is right to look for new growth drivers that will define future winners in developing-market stocks.
During the first few months of 2016, stocks in emerging markets have started to pique the interest of investors who’ve been on the sidelines in recent years. The MSCI Emerging Markets Index advanced by 4.9% in the year through June 21, outperforming developed stocks. Yet monthly performance has been very volatile, and it’s hard to erase the memory of the sharp declines in recent years. It’s still too soon to declare that a lasting recovery is underway.
But there are reasons for optimism. Although economic growth may be slower than in the past, the quality of growth in many countries has improved in recent years because inflation has fallen. For example, in India and the Philippines, inflation has declined to 5% and 2%, respectively, enhancing real income growth and improving the purchasing power of consumers. Lower commodity prices are benefiting countries that are commodity importers, such as India and China. And interest-rate cuts have become more widespread, providing an important catalyst in countries like India.
After five tough years, we think that these are all good reasons for investors to consider reallocating toward emerging equities. To do so, however, they’ll need to think differently than in the past. Even if a recovery accelerates, we don’t expect a powerful rally of equities like in 2002 and 2007, when investors could simply ride the index and enjoy very attractive returns. The good news is that there are exciting new trends that are creating pockets of robust growth and providing new points of re-entry to emerging markets.
Rethinking Consumer Spending
The rapid growth of consumer spending has always been a key feature of the emerging investment opportunity. But these patterns are changing. In some countries, in the past, consumer spending was driven by increased borrowing. Today, in key markets like Brazil and South Africa, consumers are already highly indebted, so there’s not much more room for them to borrow.
So to find above-average consumer growth, it’s important to focus on developing countries where consumer debt levels are very low. For example, in the Philippines, Colombia, Peru and Indonesia, consumer debt accounts for a much lower proportion of GDP than in other emerging markets.
Consumer trends play out differently in various countries. In Russia, hypermarkets are growing rapidly because they offer much lower prices than traditional retailers. Convenience stores in Thailand are booming. And rising demand for private education is defying domestic challenges in China.
Don’t Ignore China
For many investors, slowing economic growth in China is a deterrent. We think that this is the wrong approach. Instead of ignoring China, consider the course of transition in the world’s second-largest economy.
It’s true that the “old” sectors, such as manufacturing and commodities, which defined a generation of China’s rapid emergence as a global economic superpower, are fading as a source of premium growth. But there is a new China emerging that is racing ahead and defying the current slowdown in economic growth. Internet, healthcare and education companies are just a couple of the areas that we expect will continue to post above-average growth rates for years to come.
Look for Global Leaders
Across the emerging-market landscape, a number of companies have become or are becoming global leaders in their respective industries. Tata Consultancy Services of India is now a major player in the global IT services market. Taiwan Semiconductor Manufacturing is leading the global semiconductor foundry industry with dominant market share, advanced technology and the highest margins among its peers. Aspen Pharmacare is becoming a global leader in emerging markets in branded and generic pharmaceutical products.
Many of these companies may not quite be household names for international investors. In our view, it’s only a matter of time before some of these established and rising stars in emerging markets make it to the top. Investors who can find them today can purchase exceptional growth potential at very attractive stock prices.
These are just a few ways in which investors can start to think about finding a way back into emerging-market equities. The key is to identify industries and companies that have attractive growth prospects, even in an environment of sluggish growth. Stocks of companies like these can be expected to do well even as market challenges persist, while providing excellent positioning for a potential sustained longer-term recovery of emerging-market equities.
This article previously appeared in Citywire.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.