Emerging Market Economies🐣

December 5, 2022

Emerging Market Economies

Approximately forty countries are classified as emerging market economies

Although there is no single description of what defines an emerging market (EM), common country traits are relatively rapid economic growth when compared to developed economies (think +3% to +6% or more annual growth), rapidly increased productivity levels, and increased middle class (which also usually means increased urbanization).

What are the attributes of emerging market countries from an investment perspective?

Emerging bonds: Emerging market (EM) credit (i.e., bonds or debt) should regain a reasonable foothold over the next 12 months specifically because of all the macro challenges it faced in 2022, including pandemic recovery, rising inflation, food insecurity, energy shortages and dislocations, the unstoppable ascent of the U.S. dollar, hawkish central banks, diminished liquidity, Russia’s invasion of Ukraine and its resultant migration crisis in eastern Europe, zero-COVID policy lockdowns in China, lower global economic growth, and the ravages of droughts and floods from global warming—honestly, there’s been no shortage of huge macro challenges this year🙄

Emerging adversity: There is always going to be some sort of adversity. Emerging-market dollar-denominated bond performance lagged this year as U.S. interest rates ascended from historically low levels (even though Fed Chair Jerome Powell towards the end of 2021 was declaring that rates would stay lower for longer)—A stronger U.S. dollar (which the Federal Reserve helped inflame) makes imports more expensive for nearly every other country and weighs on global economic growth and trade

Emerging rate cycles: Some EM countries—like Mexico, Brazil, and Chile—that were early to raise rates may be near the end of their central bank rate-hiking cycles ➜ Thus they may have room to lower interest rates and stimulate growth📈

Emerging debt: EM debt is not stupid cheap—there is still room for risky assets to get worse before they get better—but recent yields levels potentially offer a strong income return (aka carry) while investors wait for peak inflation, a change in U.S. Federal Reserve policy (aka a Fed pivot), economic recovery, or compelling returns⏳

Flashback “BRICS”: BRIC was coined in 2001 by Goldman Sachs an acronym for the then leading emerging economies—Brazil, Russia, India, China—later modified in 2012 to BRICS to include South Africa ➜ Fast forward and South Africa continues to grapple with major issues and Russia is a global pariah mired in a disaster of its own making, but Brazil, India, and China are economic powerhouses that could spark with the right political alignments⚡

Flashback “Fragile Five”: A phrase coined by Morgan Stanley in 2013 to describe the “Fragile Five” EMs — South Africa, India, Indonesia, Brazil, and Turkey — because they had high inflation, large current account deficits, challenging capital flow prospects, weak currencies and weak growth ➜ Fast forward and South Africa remains fragile; but India, Indonesia, Brazil, and Turkey are economic powerhouses with the 2nd, 5th, 8th, and 17th largest economies in the world

More flashback acronyms: MINT (Mexico, Indonesia, Nigeria and Turkey) minted in 2014 by Fidelity Investments; Next Eleven or N-11 (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey, and Vietnam) coined by Goldman Sachs; and the never catchy phrase CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa) coined in 2009 at the Economist Intelligence Unit (EIU) ➜ Acronyms come and go, but the demographics behind EM growth catch on occasionally

Emerging views: And yes, my views have also changed over the years—as they should—see “Around the World with Investment Skeptics

Future forward: By 2030, four of the largest seven economies (in nominal GDP terms) will be EMs and six of the largest eight in purchasing power parity (PPP) terms will be EMs — “Inconceivable! Emerging market might not mean what you think it means”* — By 2040, the 10 largest emerging economies will be double the size of the 10 largest developed** economies🤺

Whipping boy, emerging victim, or risk off? Sometimes the problem — from an investment perspective — is not directly with an emerging country or even emerging markets in general, but with investor risk appetite ➜ When a crisis occurs and investors want to decrease their portfolio risk, EM assets are often one of the early things to be jettisoned (sold off); and because EM assets have relatively thin or small markets compared to developed economy assets, their prices tend to decline faster

How do you invest?

EM investing: Strategically, there are two general ways to invest in EM growth

  • Direct exposure through EM investments (stocks, bonds, alternatives, and limited partnerships)
  • Indirect exposure through developed economy multinational companies (DM stocks, bonds, alternatives, and limited partnerships) that derive a large or growing proportion of their profits or revenues from EM countries

Indirect exposure through international and multinational companies is likely how most U.S. investors attain EM investment exposure (even if they don’t realize they have it).

Thus, with EMs set to “inconceivably” overtake developed markets in economic sway, thinking through EM allocation and exposure should be increasingly important to your portfolio.

Emerging Markets Economies
Emerging Markets Economies — Graphics and design by Yrtist.com

Running Point strives to maintain diversified portfolios that balance perceived outlooks with risks while we search for and analyze opportunistic investments. For some with a longer-term view that can take advantage of some illiquidity, private credit funds, specific real estate deals, venture capital, or other bespoke deals may offer unique prospects to achieve goals efficiently and effectively.

Michael Ashley Schulman, CFA
Partner, Chief Investment Officer


ENDNOTES

* A reference to the 1973 novel by William Goldman as well as the1987 movie of the same title, “A Princess Bride”

Vizzini: He didn’t fall? Inconceivable.
Inigo Montoya: You keep using that word. I do not think it means what you think it means.

** Developed market economies include Australia, Austria, Belgium, Canada, Denmark, Finland, France Green, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, South Korea, Spain, Sweden, Switzerland, United Kingdom, and the United States.


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