Emerging equity markets are rich in possibilities for globetrotting investors. But great investments are often where you least expect to find them. Here are three themes we think deserve a bigger spotlight.
1. Europe’s New Industrial Heartland Revs Up
As the extended production line of German industry, the central European nations of Poland, Hungary and the Czech Republic are in the early stages of an economic revitalization. These former Soviet satellite states form a thriving manufacturing hub, not only supplying raw materials and components but also assembling cars and heavy machinery. Industrial production in the region has rebounded sharply over the past year (Display), fueled by growing demand from a healing eurozone and, particularly, German manufacturing.
Financial-services stocks offer an attractive gateway to this unfolding recovery, in our view. The region’s banks suffered huge losses on foreign-denominated household and corporate loans in the wake of the European credit crunch and recession. But with economic activity picking up and balance sheets now largely repaired, these institutions look poised for stronger and more profitable loan growth. Rising local real estate values, record-low unemployment (supportive of strong real income growth) and the prospect of higher interest rates as inflation revives should also help. What’s more, central Europe accounts for less than 2% of the MSCI Emerging Markets Index, so passive investors won’t benefit much from this trend.
2. The iPhone 8 Supercycle
This year marks the 10th anniversary of the iPhone’s debut, and rumors are rampant that Apple plans to celebrate the milestone with the rollout of an innovation-packed iPhone 8 this fall. Industry talk suggests that the phone will boast a completely new design, including such features as a next-generation organic light-emitting diode (OLED) display, 3D sensing, an all-glass enclosure, vertically stacked camera lenses and wireless charging.
Whenever it arrives, we expect the iPhone 8 to set off a massive shakeup of the Asian technology supply chain—richly rewarding well-positioned players and leaving tech laggards by the wayside. For example, backlighting (a technology used to support LCD displays) could become obsolete if OLED displays take off, and it’s unclear whether metal casings will be as prominent as they have been. We expect big winners and losers, so it will be imperative to gain a deep knowledge of these new technologies and the likely competitive shifts the next-generation iPhone may foster.
3. EM-Savvy Global Brand Champions
As the global economy gains a firmer footing, we expect some of the best emerging-market (EM) investments to come from outside emerging markets. Some investors consider this cheating, but we’d argue that, selected carefully, such investments can be a more attractive way to gain exposure to developing-world growth. After all, investors need to stay open-minded and should always be evaluating opportunities through a global lens. As important, these companies tend to have better governance than their EM peers.
The enduring love affair between global brands and EM consumers makes it essential to understand the key factors influencing these shoppers’ tastes and aspirations. We’ve identified a handful of EM-focused multinational brands offering high, stable cash flows and generous cash-return policies. They cover an array of industries, including world-renowned household and personal-care products, athleisure wear and American fast-food restaurant franchises. High-end luxury brands also fit the bill.
As affluent shoppers from emerging Asia, Latin America, Russia and the Middle East snap up iconic cars, watches, leather goods, jewelry, wines, spirits and cosmetics, they could account for roughly half of the world’s luxury market by 2020, according to Bain & Co., up from an estimated 40% in 2016. Established European heritage brands such as LVMH (Moët Hennessy Louis Vuitton, owner of Christian Dior and Givenchy), Richemont (owner of Cartier), Gucci and Hermès enjoy ages-old legacies that are impossible to replicate. These brands continue to open exclusive shops in fast-growing cities across the developing world and expand their online presence. But a major chunk of their growth is still likely to come from wealthy EM tourists, who love to buy luxury items when traveling abroad (Display). Fundamental research can help investors determine which companies will benefit most from these trends.
Cast a Wider Net
With fundamentals strengthening and valuations still enticing, especially relative to developed-world stocks, we continue to see huge payoff potential in EM stocks. Transformative forces are driving new sources of growth and prosperity across the developing world. While there is no shortage of opportunities, EM investors should be selective. In our view, an active “smoother-ride” approach that favors stable, cash-generative business models and strong balance sheets, while also considering valuation, is the right strategy for navigating the inevitable twists and turns of these inherently more volatile markets.
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.
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