Emerging market equities sold off significantly late in the first quarter, with every country and sector within the MSCI Emerging Markets index down, impacted by the global spread of the COVID-19 pandemic. While the energy sector was the hardest hit, we saw quite indiscriminate selling, including consumer-oriented names which typically are resilient in an economic downturn.
Under these conditions, investors must triple-check their investments. There are essentially three types of businesses: 1) those that will be challenged short term and long term; 2) those that are challenged short term but which should recover, and 3) companies that are less affected short term and which should actually do better in the long run. We think investors should focus on the companies that fall in the second and ideally in the third categories.
Investors need to consider the short- and long-term effects of the liquidity squeeze in emerging markets. Many EM countries have learned their lessons from past crises and have recognized the need to issue debt in local currency rather than U.S. dollars. As a result, they are in a good position to survive the short-term effects of a stronger dollar. Brazil is a good example with over 90% of its government debt predominantly issued in local currency. Over the long term, many emerging markets have also learned the importance of fiscal discipline. In our view, major emerging markets that have maintained fiscal discipline are good places for investors to be.
China entered the pandemic crisis earlier and thus began emerging earlier. As a result, some Chinese stocks have performed relatively strongly. For example, Chinese bank stocks have benefited from government policy to extend rather than foreclose loans. However, we believe that there are better opportunities in other sectors.
Online retailers like Alibaba and entertainment companies like Tencent held up well during China’s lockdown. As restrictions are lifted in China, we expect that consumers will have formed new habits and these businesses will have gained new customers for the long run. Large numbers of people working from home has also put pressure on companies’ IT capacity. We expect demand for cloud-based services to continue to increase following the crisis, in turn driving demand for memory and logic chips.
India’s lockdown response may be different in major cities than in rural areas, as many millions still live a hand-to-mouth existence. In its favor, the country has a young population with a low proportion of over-65’s. Investors will need to look closely at the long-term prospects of businesses they own. However, there are strong companies in sectors like IT services, which are less exposed to the domestic market and are providing critical support for businesses around the world.
The commentary is the opinion of Vontobel Asset Management. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
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