Emerging Markets: Investment Opportunities in 2021

2020 put a considerable strain on individuals, communities, governments, and markets around the world.

Economies and markets globally have primarily been impacted by the first-order impact of COVID-19, including lockdowns and movement restrictions, as well as near-term supply chain and consumption disruptions, resulting in significant GDP (gross domestic product) declines.

Across countries, sectors and companies there have been clear winners and losers from COVID-19, which in some instances have confounded expectations. It is clear that key emerging markets, particularly in East Asia, have substantially outperformed other countries in terms of health outcomes, economic impact and equity markets.

Looking forward to 2021, COVID-19 will remain prevalent and while the outlook for a vaccine is improving, production and distribution in sufficient scale are challenges equal to its development. As such, countries will continue to experience sporadic COVID outbreaks, which will add volatility to the underlying trend of economic and market recovery.

We also anticipate that the second-order effects of COVID-19 to become more evident. These would include fiscal and monetary macroeconomic risks resulting from the unprecedented stimulus policies pursued globally to mitigate the effects of the pandemic. In addition, inequality has widened globally both within and between countries, increasing the risks of political instability.

Less susceptible to these risks in 2021 will be those countries that were better able to minimise disruption during 2020, notably East Asian emerging markets.

Gravitating Towards Strength

As recovery becomes more widespread across emerging markets, earnings visibility will improve, enabling a broadening of market performance. Many good quality companies, beyond the obvious COVID-19 winners, have successfully navigated the pandemic and will emerge out of the crisis in a stronger competitive position and with valuations that have corrected significantly beyond the limited near-term impact to their intrinsic value.

In 2021, East Asia will remain well placed to lead global markets. China is expected to be alone in seeing GDP growth in 2020, underpinned by a diversified domestic economy driven by innovation and digitalisation. We continue to see the emergence of high-quality companies that are well-placed to benefit from ongoing market consolidation and booming domestic consumption. Taiwan and South Korea will continue to benefit from the structural growth in information technology (IT) hardware, as well as the diversification of global technology supply chains.

While it is likely that with a new US administration there will be a shift to a more constructive tone when it comes to relations between the US and China, tensions will remain. Regardless of this, the economic imperative for US companies to grow, develop and sell into, as well as source from China, will ultimately drive US policy. We have also seen the continued liberalisation in China’s financial markets which has driven increased foreign ownership and over all there has been rising investor appetite for China’s domestic A-share markets.

Next Wave of Recovery

While the ASEAN (Association of Southeast Asian Nations) region and India have lagged in terms of COVID-19 normalization they are gradually re-opening, with macroeconomic recovery supported by a younger, less susceptible, population. The case for foreign direct investment is being improved by regulatory change and global supply chain diversification, while the significant scope for consumption growth also bodes well over the longer term.

Although the disruption of traditional business models has weighed on some companies, we expect to see a positive impact on Indian technology service providers in 2021. Largely ignored over the last few years due to slowing growth and margin pressures, the IT services sector has been supported by both higher client traction as well as structural cost saving initiatives. The resurgence of manufacturing activity, as India embarks upon indigenization and import substitution, as well as global efforts to diversify supply chains, could drive demand across a range of product categories, including electronics, defense, automobile parts and pharmaceuticals. Normalisation of credit stress on the back of falling interest rates and improving liquidity should have a positive impact on banks. Negative real rates in India will provide very significant support for the economy and markets going forward.

In Latin America, COVID-19 has accelerated a trend of low interest rates and digitalisation. Simultaneously, a strong global rebound in the manufacturing supply chain has boosted metal prices, supporting the region’s mining industry after a long cycle of underinvestment and weak currencies.

Brazil has continued to focus on important economic reforms that are leading to a structural downward shift in its historically high real interest rate. The central bank has also cut its policy interest rate to a record low, reducing the cost of renegotiating or restructuring loans, possibly providing a catalyst for longer-term credit growth. This has historically been far below many other markets and would support the prospects for the financial sector in 2021.

Even in South Africa, an emerging market that has stagnated in recent years, there is cause for optimism. The outlook is improving under President Cyril Ramaphosa, with announcements of a host of reform measures and redirection of public spending, including infrastructure projects, initiatives to support re-industrialization, spending cuts (centered on a civil servant wage freeze) and efforts to address corruption.

A Better Future

The challenges of 2020 have highlighted structural advantages and other beneficial secular trends in emerging markets that bode well for 2021. The resilience of key markets in East Asia during the crisis, paired with their ability to capitalize on secular shifts to the new economy, should drive continued strength through 2021. India and Brazil, who have struggled in comparison to other emerging markets, will likely benefit from a uniquely accommodative environment of negative real rates (and an undervalued currency in Brazil), paired with ongoing reform efforts and excess capacity in the economy, boosting growth.

This broadening of economic recovery creates a compelling investment opportunity for all types of investors across emerging markets as a whole.