18 Dec 2020
Raheel Altaf, manager of the Artemis Global Emerging Markets Fund
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2020 has been a year of extremes and the unexpected. But there are reasons to be more optimistic about the prospects for emerging markets in 2021.
The performance of emerging market equities during 2020 was driven by the path of the pandemic and global macroeconomic factors. Global equity markets endured one of their steepest falls in history as the economic risks of the pandemic became clear.
The aggressive policies by governments and central banks which followed led to a period of stabilisation. Asian countries, in particular, were able to restart their economies relatively quickly. Having dealt well with the virus, they took steps towards economic recovery. The resulting recovery in asset prices was also one of the sharpest in history. Overall, emerging market stocks are up around 15% in US dollar terms in 2020.
Looking over the last decade, they remain a significant laggard and this represents an opportunity. Compared to US equities, the relative valuations of emerging markets indicate an attractive entry point.
Emerging markets long term valuation relative to the US
There are reasons to believe that emerging market stocks will fare better in the next decade, but the outlook during the shorter term is likely to be dominated by sentiment. So what can investors expect in 2021?
Hopes for a smooth roll-out of Covid-19 vaccines, monetary policy which remains supportive and positive economic data all point towards recovery. Global economic activity continues to expand, albeit at a more moderate pace compared to previous months. Services PMIs have also moderated in most parts of the world except in China, which saw further acceleration. Asian economies have returned to normality in reasonable financial strength and yet investors are yet to shift their capital to reflect of these trends.
We expect this shift to occur and start to gain traction in 2021. The steps that economies – particularly in Asia – have taken to protect themselves against demand shocks from the West should see them becoming more self-sufficient. Their favourable demographics and faster growth, led by demand from local (rather than Western) consumers should support longer-term growth.
More broadly, markets outside of Asia have the potential to deliver strong returns against this backdrop. Latin American and eastern European stocks have been laggards in 2020. But there are signs that last year’s losers are turning the tide, particularly as the effects of stimulus spur growth and demand.
Undoubtedly, some developing economies could experience slower growth. Some emerging economies, such as Brazil and South Africa are facing economic difficulties because of fiscal positions that are already stretched. Any disappointment in growth is likely to increase stresses within these economies and create volatility. Furthermore, a stronger US dollar would introduce additional discomfort. While the number of emerging economies exposed to high levels of debt denominated in US dollars is lower than it used to be, the performance of the dollar still has material impact on those that are more exposed.
The outcome of the US election was viewed as positive for emerging markets. However, any further escalation in tensions between the US and China would concern markets.
In the last few years, the longer-term trend of globalisation has faced some challenges. This has created opportunities as supply chains have shifted from China towards other emerging markets such as Vietnam, Mexico and Poland.
The pandemic has significantly accelerated a number of existing disruptive technological trends that have become popular among investors in the last decade. We have seen an undeniable increase in demand for memory chips, helping to power data centres and cloud services, which are vital for stay-at-home workers. Large parts of the economy have been shut or restricted, yet internet businesses have been insulated from this and thrived.
Yet, as we look at emerging markets today, we continue to prefer the ‘unloved’ areas of the market. Valuations of some companies are at levels that are more attractive than they have been for some time. As expectations for a cyclical recovery and roll-outs of vaccines encourage intra-market rotations, we see a number of opportunities. Signs of improving demand for cars are apparent in Asia. A similar story of better-than-expected activity is emerging in another out-of-favour sector: resources. Yet there is disproportion in the way companies are being rewarded for these improving trends.
It is therefore our belief that the best returns will be found in stocks which are undervalued. But a strong discipline has been required because these companies have been out of favour for some time. Improving trends are yet to be picked up by investors and our belief is that these are the sorts of companies that offer exceptional rewards. The last few months have seen significant rotations in the market, with value stocks (those that trade on below-market valuations) benefiting after a long period of poor performance when compared to growth.
For some time we have discussed the opportunity in value stocks. Indeed this has become uncomfortable, given the really poor performance in the past few years. The gap between low and high-value stocks has become much larger. Across most regions, dispersion is extremely high versus history. The inevitable snapback is likely to be highly favourable for value stocks and emerging markets have plenty of opportunities in this area.
Looking back through the last few decades, the last time growth stocks outperformed value stocks by such magnitude was in the Technology Media and Telecoms (TMT) bubble at the turn of the millennium. It is well known that growth stocks underperformed very sharply after the peak of the TMT bubble. We expect history to repeat itself and, having positioned the fund accordingly, we are optimistic about the prospects for emerging markets in the next year.
In challenging times, the need to maintain a disciplined approach to investing is crucial. Backed by the same investment process, we remain confident that the strategy is well positioned to deliver better returns for our investors in the years ahead.
To find out more about the Artemis Global Emerging Markets Fund and its positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
Artemis Global Emerging Markets Fund
The fund is a sub-fund of Artemis Investment Funds ICVC. For further information, visit www.artemisfunds.com/oeic.
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