Optimism in Asia Drives Emerging Market Outperformance in October

Despite the COVID-19 pandemic, emerging markets have shown a continued appetite for structural reforms that could lay the foundation for lasting economic recoveries, according to our Emerging Markets Equity team. Here are some highlights of news and events driving emerging markets during the month of October, and where the team sees opportunities today.

Three Things We’re Thinking About Today

  1. Emerging market (EM) small-capitalization (small-cap) stocks outperformed their large-cap counterparts over the last six months. A catchup from the sharp underperformance in the first quarter was a key driver of the stronger EM small-cap recovery. EM small caps have attracted less investor attention due to the growing market concentration of performance in a handful of mega-cap companies, as disruption from the COVID-19 pandemic drove interest in technology giants. But as we see normalcy return more rapidly in key EMs, this should enable broader economic and market recovery, as evidenced by the recent outperformance of EM small caps. We believe that the long-term structural story for EM small caps is not undone and remains compelling, underpinned by domestic economic drivers and the consumption growth story. As such, we believe that dedicated small-cap exposure should be viewed as complementary to large caps.
  2. Despite the COVID-19 pandemic, EMs have shown a continued appetite for structural reforms that could lay the foundation for lasting economic recoveries. China, for example, has stayed true to its longer-term goal of making domestic consumption a major economic engine—and a source of potential ballast during external demand shocks. The government’s recent moves to boost local luxury consumption tie in with this ambition as officials relaxed duty-free shopping rules, igniting a surge in duty-free sales in China. We see China’s domestic travel and duty-free industries heading for a boom in the next few years. India’s sizable fiscal deficit has limited the government’s ability to spend on shoring up its economy. We expect privatizations and other economic reforms to offer more support by attracting investments. The country’s “Make in India” initiative, aimed at growing the manufacturing sector, appears well placed to benefit from several trends. Brazil has also continued to pursue structural reforms despite economic disruptions and political noise. Officials recently passed new rules for the natural gas and sanitation industries in a bid to unlock hefty investments in the coming years.
  3. The recent weakening of the US dollar relative to EM currencies can be attributed to the continued challenge of containing COVID-19 in the United States, the unprecedented level of US fiscal stimulus and dovish monetary policy, and market expectations of subsequent fiscal stimulus. The weakening of the US dollar comes off the back of a prolonged period of US dollar strength relative to most currencies. We expect some reversal of this previous trend of US dollar strength, but view it unlikely for the US dollar to give up all its gains relative to EM currencies in the near to medium term given global economic uncertainty, low US inflation expectations and the continued importance of the US dollar as the global reserve currency. The weaker US dollar is generally beneficial for EM equities—and especially Asian equities— with many companies domestically oriented. As such, earnings should improve in US dollar terms. A weaker dollar also gives emerging economies more leeway for fiscal measures.