EM isn't a blanket growth story

A lot of clients wonder if now is a good time to invest in emerging markets. Not to be wishy washy, but it depends on where you look. The EM is not the monolithic hypergrowth, and hyper-recessionary, asset class of the past. Just as in developed markets, there are significant differences among emerging economies and companies. So, to borrow a phrase from our CIO on fixed income broadly, it’s about picking your spots. Below are where we currently are mining for what we think may offer the best potential opportunities in EM:

• India, Indonesia and Thailand Though dampened somewhat from slowing global demand, economic activity in all three countries is accelerating. India is targeting 6.5% GDP growth this year, and Indonesia is coming off its best year for growth in nine years. That said, with much of China’s growth falling within its borders as the masses emerge from their Covid caves to splurge on dining, entertainment, travel and other leisure services, there’s been limited spillover to other countries. Still, with what’s made in China largely staying in China, and with Russia’s prolonged war on Ukraine spawning shortages of key commodities, India and Indonesia are stepping in to help fill the void. Thailand, meanwhile, expects a boom of tourists from China.
• Early bird inflation fighters Tightening credit conditions brought on by the recent banking panic and the years-long global central bank battle against inflation are threatening further deterioration in the world economic outlook. EM countries took on the inflation fight well ahead of the Fed, ECB and other developed market central banks. Brazil, for example, raised its policy rate by 75 basis points in March 2021, a year before the Fed made its initial and smaller hike, and Mexico has raised its policy rates 725 basis points since June 2021. This has put these and other Latin American countries such as Chile, Colombia and Peru in a better position to defend their currencies and initiate potential easing. But continued hyperinflation in Argentina offers a counter cautionary tale that what works in one country doesn’t necessarily work in another.
• Focus on quality and a diversity of income With large and growing middle classes, more stable governments and better corporate governance, many EM countries have matured to near-developed status. As such, their growth premium has become smaller, but so have their associated risks. In this more muted environment, we think the key is to home in on companies with solid balance sheets, strong cash flows and diverse sources of revenue, both internally and externally. Not as many home runs, but not as many strikeouts, either. Internal country demand remains the driver. But external sources of revenue and income provide a buffer, particularly during times of potential distress at home.

From a broader perspective, we like EM, where aggregated growth is on track to outperform the U.S. and other developed markets. Indeed, the EM is one of the few areas where we have above-benchmark exposure in our fixed-income models—even if spreads (the gap between EM and Treasury yields) were to widen from current levels, the coupon is high enough to offer potential lower downside risk from capital depreciation. But from our perspective, with the EM story not one but many, the best opportunities lie in being selective. Again, it’s all about picking our spots.