Within EMs, the IT sector (the only sector expected to see earnings decline this year) has been the main driver of lower earnings estimates, with EPS growth expected to fall 29%.4 The decline in the semi-conductor cycle, compounded by the downturn in global trade, has hit countries such as Korea, resulting in a sharp decline in EPS estimates for the country in 2019. Taiwan, another big player in the tech sector, is also expected to see earnings decline, by 1.9%, this year. In our view, this could open up some good value plays, given the still-impressive growth potential for big tech names as disposable incomes rise and domestic consumption grows. Brazil is the only major market with sizable earnings estimate upgrades in 2019.
In our view, the pessimism around prospective earnings for EMs this year may be overdone given the likely impact of more accommodative policy around the world and the latent impact of Chinese fiscal stimulus. EM exports have yet to recover from last year, however, and may continue to be depressed by the trade conflict. Weakness in global industrial growth and demand for electronics such as smart phones may be nearing a bottom. Forward valuations are at, or slightly above, long-term averages, so steady and strong earnings growth over the next six to 12 months is necessary for EMs to hold onto and add to recent gains.
Dollar, Oil, and Trade Risks
As became clear in May, markets had grown somewhat complacent about the potential impact of trade risk. Since then, this risk has been re-evaluated. Many observers still expect the US and China to find a way to co-exist peacefully but the changing nature of the relationship between these world powers means it will likely remain a latent threat for years to come.
Despite the recent shift in Fed expectations, lower US Treasury yields, positive Chinese economic data surprises, and a seven-to-eight-year US-dollar rally, the dollar remains strong relative to its history. For this to change, economic growth in the rest of the world, particularly in Europe, needs to recover. The eurozone went into a technical industrial recession in the second half of 2018, which has knock-on effects for EMs in terms of weaker demand for exports and smaller capital flows into EMs. While there are some signs of stabilization in Europe, the current outlook is poor relative to elsewhere. In a climate of a strong dollar, dollar-denominated debt obligations become more expensive and the weakest areas such as Turkey and Argentina are often required to borrow more in hard currency than in local currency as confidence in their own markets wanes. Non-financial corporate EM hard currency (HC) debt is up by over US$2 trillion since 2009, pushing total EM HC debt to US$5.3 trillion in 2018.5
The strong US dollar combined with higher oil prices – denominated in dollars – provides a double hit to net importers such as India and China. However, the impact is greater for smaller economies such as Indonesia, South Africa, and Turkey. While China continues to face debt issues, we believe these are manageable and its consumption story remains intact. India, despite its infrastructure and employment challenges, has the potential to capitalize on its demographic dividend over the long term.