After several tumultuous months, emerging equity markets are rebounding – but there are still plenty of opportunities to uncover and risks to watch. Despite the turmoil, we’ve managed to find paths to outperformance during this period. As we look forward to the coming weeks and months, we’d like to share seven key points about emerging markets (EM) that are shaping our own EM equities portfolio right now.
Uncertainty remains regarding the strength and durability of the rebound, but the fact that the conversation has turned to improvement is, in itself, a positive. This has given us greater confidence to add some back to our bank names, a sector we downsized going into the COVID-19 crisis. Asset-quality risks in the banking sector are severe, but they appear to be more than priced in at this stage. In addition, we’ve trimmed select China consumption names to manage position size on strong performance.
Retailers with a strong e-commerce presence have experienced positive sales growth in April and May despite the COVID-19 crisis. For example, Brazil’s Magazine Luiza, also known as Magalu, registered physical store sales growth of -84% in April and -53% in May, reflecting the impact of store closures due to COVID-19-related lockdowns. Over the same period, however, Magalu’s e-commerce sales grew substantially over the same period, with total e-commerce sales growth of 138% in April and 203% in May. The increase in e-commerce sales at Magalu more than offset the effect of physical store closings, leading to 7% total retail sales growth in April and a whopping 46% total retail sales growth in May. Furthermore, this growth has been driven not just through increased volume per customer, but the addition of new customers. We expect these gains in market share to be sustained, helping our positions in Magazine Luiza and in other e-commerce names such as Mercadolibre, Alibaba, and JD.com.
Semiconductor manufacturers TSMC and Samsung are among the dominant suppliers in EM that are gaining ground in the wake of the crisis as supply chains become more localized. Samsung has a strong position and rational capex plans in dynamic random-access memory or “DRAM,” while TSMC has affirmed its long-term competitive position. China-headquartered Silergy Corp., which manufactures power-management integrated circuits, is also likely to benefit from a larger local market share.
US/China tensions are real and remain a risk, but we believe financial interests will ultimately dictate behaviors, mitigating harsh outcomes. The best way to play China today, in our view, remains domestic consumption – a trend that seems quite durable. In addition to the Chinese e-commerce names already mentioned, we think education services firms such as TAL and communication services companies such as Netease and Tencent merit consideration.
Today’s infrastructure investments in China are much more focused on accelerating digitization and less so on bullet trains and subways (see Figure 5). Heightened trade tensions and the COVID-19 crisis have combined to reinforce China’s strategic plan of “Made in China 2025.” The biggest beneficiaries of this will be Greater China names as China seeks to become both producer and consumer of higher-value add products and services. The shift in focus of China’s infrastructure spending will benefit China and Asia more and the rest of emerging markets – and the world – less than in the past.
The correlation of the US dollar index to the EM equities index tends to be quite solid (see Figure 6). We view EM currencies currently as inexpensive and we expect that the dollar will weaken as the crisis atmosphere normalizes. This, together with the backdrop of low yields, quantitative easing, and the US Federal Reserve providing dollar liquidity, creates a favorable backdrop for EM equities.
Good companies exist in countries with weaker GDP growth. While we pursue a bottom-up investment approach, we also apply a top-down macro discipline in our investment process. There is too much variation among returns to ignore sources of risk or value signals (see Figure 7). Ensuring all macro inputs are captured through our investment process has added value in the years before and during the COVID-19 crisis, and we expect this practice will continue to add value in the years to come.
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