Pandemic Accelerates New Economic Landscape for Emerging Markets

Chetan Sehgal explores what the new economy entails for emerging markets, and why companies offering diverse services have caught his eye.

    Chetan Sehgal, CFA

    Chetan Sehgal, CFA Senior Managing Director, Director of Portfolio Management, Franklin Templeton Emerging Markets Equity

    The global pandemic has accelerated a shift in the emerging market landscape, according to Franklin Templeton Emerging Markets Equity’s Chetan Sehgal. He explores what the new economy entails for emerging markets.

    Near-Term Resilience Could Spell Long-Term Opportunity for Emerging Markets

    As investors digest the latest developments and potential implications from the coronavirus, leading emerging markets have demonstrated resilience in the face of uncertainty. The latest vaccine headlines could signal a return to normalcy for some emerging markets sooner than anticipated, despite a resurgence in infections for many developed markets.

    We have seen emerging market economies react to the current surge in cases reasonably well. This suggests to us that the potential economic impact could be less severe than what we saw at the beginning of the year, where many countries were in the first phase of lockdowns to varying degrees.

    With a stronger outlook emerging, the tumultuous year looks like it could end on a more optimistic note, in our view. Some emerging market economies continue to show long-term investment opportunities through the way China, Taiwan and South Korea have handled the pandemic this year. We view this as a testament to the quality of their governance and health care systems.

    In particular, we’ve seen some positive sentiment towards Chinese equities from improved circumstances—US President-elect Joe Biden’s administration could bring more predictable US-China entanglements. This sentiment was echoed in Mexican stocks, as Biden’s victory offered investors for steadier US-Mexico relations. And, in the case of South Korea, investor optimism soared on the prospect of improved trade prospects for the export powerhouse. Elsewhere, we still believe there could be long-term investment opportunities. For example through India’s consumption story, despite the economy’s cyclical slowdown, and Brazil’s economic drivers through its demographics, continued government reforms and abundant natural resources.

    The New Economy

    The very nature of emerging markets has moved away from an old-economy model that relies on materials, energy and industrials. In its place a new economy fueled by consumer discretionary, consumer staples, information technology and communication services.

    THE ACCELERATION OF CHANGE IN EMERGING MARKETS. SHIFTING EMERGING MARKETS ECONOMIC LANDSCAPE Shrinking Old Economy, Growing New Economy. MSCI Emerging Market Index Sector Exposure (January 2007 to September 2020)

    For illustrative purposes only. Past performance is not an indicator or a guarantee of future performance.

    Sources: FactSet, MSCI. Starting January 2007 to September 2020. Old Economy – Materials, Energy, Industrials; New Economy – Consumer Discretionary, Consumer Staples, IT & Communication Services. Source: MSCI, World Health Organization, Bloomberg. Morningstar © Morningstar, Inc. 2020. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

    Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses and sales charges. References to indexes are made for comparative purposes only and are provided to represent the investment environment existing during the time periods shown. The performance of the index does not include the deduction of expenses and does not represent the performance of any Franklin Templeton Fund. See www.franklintempletondatasources.com for additional data provider information.

    In this new economy, we favor companies that display resilience to economic and other forms of disruption. One particular trend we’ve closely followed is digital disruption, which helps us weed out businesses with distinct competitive advantages in technology and innovation. We’ve seen many companies adopt new technologies and shift aspects of their business online, with examples including moving tutoring online, creating interactive shopping experiences through live streaming, to in-game monetization opportunities on gaming platforms. This has also driven an acceleration in the adoption of technology hardware, including semiconductors for cloud computing, batteries for e-mobility and greater demand for the cloud, driven by home-working, e-commerce and gaming.

    In addition, increasing numbers of companies are demonstrating a commitment toward corporate governance and broader environmental, social and corporate governance (ESG) improvement, which we think remains an underappreciated tailwind for emerging markets.

    Historically, crises have been a spur for greater innovation, resilience and adaptation to new challenges. We’ve seen emerging markets overtake some of the more advanced economies in areas such as e-commerce, e-payments and contact-tracing mobile applications. The global health crisis has accelerated various existing trends through the adoption of new technology and next-generation infrastructure, while some developed market peers have struggled to expand upon legacy systems.

    In sum, the global pandemic has brought a cloud of uncertainty, but has accelerated some long-term themes that we’ve been following in recent years. We think many of these shifts will likely continue in 2021.

     

    What Are the Risks?

    All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.