Where to Find the Best Emerging Markets Returns
Art by Jonathon Rosen
For some time, emerging markets were a great place to invest. Then that faded. But not everything is equal. The big question today is: What nations offer the best chances of outperformance going forward? We asked a group of asset and research managers what their emerging markets picks were, and they came up with a list that is primarily in Asia.
The other common element was that each of the picks have strong industrial components. While some are raw materials producers—the typical mainstay of developing economies—they all feature a manufacturing base that is expected to serve them well over the long haul.
The top five are Brazil, China, India, South Korea and Taiwan, where stock returns look to be propitious. Many of them are pretty cheap, with price/earnings ratios in the low teens, which spells bargains. The iShares MSCI Emerging Markets exchange-traded fund has a thrifty P/E of just over 11. To David Kim, a portfolio manager at Boston Partners, a key object in emerging markets investing lately is “to win by avoiding losers.”
The picks come despite a strong dollar and rising U.S. interest rates, which makes investing in America seem more attractive than elsewhere. Emerging markets “have learned how to navigate higher rates” in the U.S., says Charlie Wilson, a portfolio manager at Thornburg Investment Management. Rates are also heading up in Brazil, India and Thailand (although not in China, where the emphasis now is on spurring the economy out of its doldrums).
Of course, the appearance of China as an emerging market may seem startling at first blush: It is the world’s second largest economy after the U.S. China’s inclusion in MSCI’s emerging markets category hinges on, among other things, poverty, which used to be enormous. Because Beijing has made efforts to radically reduce poverty, some such as Alliance Bernstein believe it soon will be promoted out of these ranks. The same could be said for South Korea and Taiwan. The point is that these countries offer the best prospects at this moment.
Worst off have been nations that are dependent on raw materials alone and suffer from political problems. Colombia, for instance, faces dwindling oil reserves. For now, exports benefit from the rise in global oil prices. But the incoming president, former leftist guerilla Gustavo Petro, has promised to stop oil exploration. Meanwhile, poverty and inequality are increasing. Argentina, Chile and Venezuela suffer from similar woes. China’s recent slowdown is another headwind for commodity-centric emerging markets, as it is the world’s premier raw materials importer.
Meanwhile, the war in Ukraine is retarding economic growth in Eastern Europe, which had strong trade relations with Russia, now mostly ended. They also have depended on Russian oil, whose continued shipments are at risk. Inflation is spiraling in the region.
The MSCI Emerging Markets Index has hardly had a sparkling 2022; it’s off 16.7% as of this past Tuesday. That at least beats the S&P 500, which has lost more (21%) and is in a bear market. The emerging markets stock market momentum, which for most of the past five years has been strong, began to sputter in 2021, when it lost 3.6%.
In the 21st century’s first decade, emerging markets romped and typically far outperformed the MSCI All Country World Index and the S&P 500. The buoyant thesis about these developing economies was that, because they had so much room to grow, they would be superior choices for the long haul. Well, that was then.
After the 2008 financial crisis, emerging markets never quite got their wind back. The end of the commodity supercycle in 2015 didn’t help, as many of these economies are based on commodities. The Delta variant outbreak of the COVID-19 virus has crimped recovery in Asia’s manufacturing hubs. For the past five years through May 31, the emerging markets index logged a 0.24% annual return, versus 0.56% for the all-world measure.
A Decade of Emerging Markets Investments
All institutional assets invested in emerging markets 2012-2022
(All figures in USD Millions)
$2,500,000
$2,000,000
All Emerging Markets
Fixed Income
$1,500,000
$1,000,000
All Emerging Markets
Equity
$500,000
$0
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Q1 2016
Q3 2016
Q1 2017
Q3 2017
Q1 2018
Q3 2018
Q1 2019
Q3 2019
Q1 2020
Q3 2020
Q1 2021
Q3 2021
Q1 2022
$2,500,000
$2,000,000
All Emerging Markets
Fixed Income
$1,500,000
$1,000,000
All Emerging Markets
Equity
$500,000
$0
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Q1 2016
Q3 2016
Q1 2017
Q3 2017
Q1 2018
Q3 2018
Q1 2019
Q3 2019
Q1 2020
Q3 2020
Q1 2021
Q3 2021
Q1 2022
$2,500,000
$2,000,000
All Emerging Markets
Fixed Income
$1,500,000
$1,000,000
$500,000
All Emerging Markets Equity
$0
Q1 2012
Q1 2013
Q1 2014
Q1 2015
Q1 2016
Q1 2017
Q1 2018
Q1 2019
Q1 2020
Q1 2021
Q1 2022
$2,500,000
$2,000,000
$1,500,000
$1,000,000
$500,000
$0
Q1 2012
Q1 2014
Q1 2016
Q1 2018
Q1 2020
Q1 2022
All Emerging Markets Fixed Income
All Emerging Markets Equity
Source: eVestment
Now, however, the future looks better in:
Brazil. Latin America’s largest economy has plenty of worries, but there’s an argument that Brazil has the resources to power through any obstacles. Earlier in the year, the Bovespa index rallied on the strength of giant corporations, two of them in raw materials, one in finance: Petroleo Brasileiro (oil), Vale (iron ore), and Itau Unibanco Holding (banking).
What’s more, the nation’s central bank acted early to combat rising inflation, boosting its benchmark rate to 13.25%. It’s widely expected that the Central Bank of Brazil will ease rates next year, and good bargains can be scarfed up in the meantime, awaiting that monetary switch.
The Bovespa climbed more than 20% this year until April, then dropped; it is now at negative 4.8% for 2022. A large reason is trepidation about the October presidential election, in which arch-conservative incumbent Jair Bolsonaro faces left-wing ex-President Luiz Inacio Lula da Silva, known as Lula. Some fear Bolsonaro’s fiery rhetoric, which reminds them of Donald Trump. Others are leery that Lula will hinder Brazil’s economic health. But the leftist has surrounded himself with more moderate advisers. Either way, Brazil “will have a market-friendly election,” observes Thornburg’s Wilson.
China. Speaking of politics, the case for China is that the Beijing regime will ease up on its pandemic restrictions and the crackdown on private tech colossuses. Result of that new prediction: The Shanghai Shenzhen CSI 300 Index, which had been tumbling all year, turned around in April; it cut its losses and now is down 12% for 2022, from 23% two months ago.
The expected policy reversal is attributed to leader Xi Jinping’s desire to return the country to fast-sprouting prosperity, in time for the upcoming Communist Party National Congress in the fall. The consensus view is that Xi aims to win a third term as party chief, hence national leader. “He’ll want to keep growth up,” says Cameron Brandt, EPFR’s research director. Brandt’s firm finds investor fund flows into China are positive lately. “Institutional investors look past the COVID lockdown,” he adds.
China’s economy should expand more than 4% this year, compared with 2.6% for the U.S., a majority of analysts told Bloomberg. That China’s central bank is going in the opposite direction of most others by lowering rates helps the country.
India. China’s long-time rival has less infrastructure, and has been slammed harder by the pandemic, yet somehow has managed to maintain better economic growth of as much as 6%. Big advantages: a younger-trending population and widespread info-tech skills.
As opposed to the other nations pinpointed here, the subcontinent does not depend on exports. The S&P BSE Sensex Index is down 9.8% this year, which in relative terms is pretty decent. The International Monetary Fund estimates that India’s gross domestic product will vault 8.2% in 2022. That “is nice GDP growth,” observes HK Gupta, a portfolio manager at Sustainable Growth Advisers. That’s despite a second bad COVID-19 wave recently. But this time, the government didn’t impose lockdowns.
Aiding the economy is Prime Minister Narendra Modi’s campaign to privatize state-owned enterprises and to boost manufacturing through tax incentives to produce cars, drugs and phones, among other products.
South Korea. The economy is heavily reliant on the global economy, which is hitting the skids. The peninsular nation is “tied to American, European, and Chinese consumers, and there’s not enough Korean consumer demand to offset export” problems, says Gupta. After a laudable recovery from early-2020 pandemic lows, when stocks leapt 75% through last year, the Korean Stock Exchange Kospi Index has plunged 21% this year.
Chipmakers such as Samsung Electronics and auto companies including Hyundai Motor and Kia have been particularly thwarted by the supply-chain mess. Once the supply problems get unwound, they should do especially well, the reasoning goes.
Taiwan. Since the March 2020 low to the start of this year, the Taiwan Capitalization Weighted Stock Index doubled, then gave up 17% this year. It also is singing the 2022 supply-chain blues. The IMF pegs its GDP increase this year at a lackluster 3.2%. That condition is likely temporary.
Computer chips are the island’s biggest product, so when things open up, Taiwan should see a surge. That’s provided a global recession hasn’t occurred. “They had a fantastic two-year run,” says Boston Partners’ Kim. While other places, notably the U.S., are seeking to onshore chip production, Taiwan Semiconductor Manufacturing, its No. 1 chip company, will hold onto its most advanced technology, he says.
Other than supply chains, Taiwan’s worst nightmare is what would happen if China invaded it, a la the Russians in Ukraine.
For the patient, and absent any disasters, emerging markets should in time reclaim their glory days as the hottest investments around.
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