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Global Emerging Markets

Country allocation review 2021

14 January 2021 |
Active ESG
Fiscal and monetary stimulus programmes across the world buoyed global markets in 2020 with encouraging Covid-19 vaccine trial results providing an end-of-year boost for investors. However, macroeconomic data is mixed: there has been a lower-than-expected improvement in the service sector and inequality is rising. In addition, in the absence of structural reforms, the economic damage from the ongoing pandemic will impact long-term growth prospects. Here, we consider our 2021 country allocations for global emerging markets.

After the bounce: improving world economy flashes mixed messages

Global and emerging markets have rallied 68% and 70%, respectively, since the March 2020 lows. The Joe Biden victory in the US election followed by the announcement of several highly effective vaccine candidates buoyed market hopes late in the year of a sustained economic recovery after the initial V-shaped bounce. Today we examine key indicators to assess whether the macro data supports an emerging markets (EM) recovery against a backdrop of improving world conditions.

Sentiment improved in the latest survey as imminent vaccine roll-outs boosted consumer confidence that the US would soon exit the Covid-19 pandemic.

Figure 1. The state of the US consumer

Chart showing the state of the US consumer

Source: Bloomberg, as at December 2020.

But a couple of factors could moderate the growing upbeat mood, including:

  • a growing partisan divergence in economic outlook with Democrats becoming optimistic compared to Republicans;
  • an unexpected fall in confidence in November as Covid-19 infections rose; and,
  • deteriorating financial conditions for lower-income households which experienced a fall in income – something that last occurred in March 2014.

The data suggests still-fragile consumer sentiment will likely remain subdued until there is a clear path out of the pandemic (subject to the roll-out of the vaccines) combined with timely financial support to repair the economic damage.

Figure 2. German business sentiment

Chart showing german business sentiment

Source: Bloomberg, as at 31 December 2020.

German business morale improved in December after falling for the second month in a row in November. The country has seen rising uncertainty surrounding the spread of the virus as curbs on economic activity hit the service sector. While the German economy is resilient the recently imposed hard lockdown will likely prevent the economy from operating at full potential.

Figure 3. Japan manufacturing momentum

Chart showing Japan manufacturing momentum

Source: Bloomberg, as at December 2020.

Business sentiment in Japan improved following the slump in the June quarter. Exports to the US and China boosted conditions for large manufacturers although coronavirus fears muted the mood in the service sector amid restrained domestic consumer activity.

Despite the recent improvement the sentiment index remains in negative territory and below pre-Covid-19 levels. Meanwhile, the government announced a US$708bn stimulus program, boosting spend on low-carbon initiatives and digital technologies.

Figure 4. China fixed asset investment trajectory

Chart showing China fixed asset investment trajectory

Source: Bloomberg, as at December 2020.

In addition to consumption, fixed asset investment (FAI) is one of the vital drivers of the Chinese economy. Over 2020 the overall FAI in China rose slightly, albeit spurred mainly by the property sector (up 6.8%) with investment in both manufacturing and mining falling 9% and 3.5%, respectively, in the same period. Chinese authorities commonly boost property investment as a short-term tactic to shore up the economy.

Although China has bounced back to pre-Covid levels, lower-income households have seen a drop in their wealth levels in contrast to their wealthier counterparts who reported gains.

Fiscal stimulus to the rescue: why governments must target spending to save economies

According to the International Monetary Fund (IMF), the G20 provided US$12tn in budgetary and liquidity support to cushion the economy during the pandemic. The scale of the financial support has ensured a sharp V-shaped recovery.

However, the recovery pace has been uneven with evidence of rising inequality, possibly requiring additional targeted fiscal stimulus. Recently, lawmakers in the US agreed on a US$900bn stimulus package that will provide $600 to individuals earning $75,000 or less in annual income as well as relief such as rental assistance, funds for small businesses and aid to troubled sectors. Elsewhere, Japan recently announced US$708bn worth of financial support, including spending on low-carbon and digital initiatives.

Of course, something is always better than nothing but the stimulus package probably comes a little late to reverse the economic damage already done to lower-income households and businesses forced to lay off workers. The incoming Biden administration will likely need a much larger and targeted spending plan to breathe life back into the US economy.

But according to European Commission and IMF estimates,  general government deficits should  moderate in 2021.

 Figure 5. General government deficit and gross debt expected in 2020 and 2021 (% of GDP)

Chart showing general government deficit and gross debt expected in 2020 and 2021 (% of GDP)

Source: European Commission Autumn 2020 Economic Forecast, IMF World Economic Outlook database. Notes: The general government deficit-to-GDP ratio is measured on the left axis, whilet he general government gross debt-to-GDP is measured on the right axis (RHS). *The EU aggregate is formed by the aggregation of the country data in euro, with consolidation where appropriate.

Many governments will need to reduce deficits to ensure debt-to-GDP ratios remain at sustainable levels.

Clearly, falling deficits imply that the scale of fiscal support in 2021 would be lower than 2020 levels. Hence, governments need to target any stimulus spending on measures designed to benefit the real economy. Monetary policy alone is insufficient to rescue economies as banks are generally risk-averse; instead, central bank liquidity usually morphs into asset bubbles. Futhermore, individuals in receipt of government hand-outs tend to hoard cash instead of spending, limiting the velocity of money and impact on the real economy.

Infrastructure spending has been touted as one effective outlet for government largesse in many economies. However, infrastructure investments tend to require long gestation periods with benefits only accruing over the long term. Also, infrastructure projects require extensive planning and feasibility studies to ensure they are ‘shovel-ready’. Despite the limited short-term impact, such longer-term capital investments are necessary to enhance economic competitiveness, ease of doing business and steady job creation.

Rates steady but inflation signs ahead

In the wake of the Covid-19 crisis central banks have supplied significant monetary policy support in the form of rate cuts, balance sheet expansion, large scale asset purchases and ensuring at least some benefits of easy money pass to the real economy.

Figure 6. Central bank rate cuts over the last 12 months

Chart showing central bank rate cuts over the last 12 months

Source: Bloomberg, as at 31 December 2020.

Undoubtedly, the central bank actions have helped but rising inflationary pressure is a risk for the global economy if monetary easing is left unchecked.

Figure 7. US 30-year breakeven inflation rate

Chart showing US 30-year breakeven inflation rate

Source: Federal Reserve Bank of St. Louis, as at December 2020.

Although the Federal Reserve (Fed) has signaled that it will tolerate inflation at a higher rate to ensure economic stability, the availability of vaccines and fiscal stimulus could narrow the slack in the economy sooner than anticipated.

Several beaten-down sectors such as travel and hospitality could witness consolidation and reduced supply adding inflationary pressures to the mix: the base for comparison will be lower from April 2021 onwards as consumption was depressed in 2020.

Similarly, commodities hit a multi-year low in 2020 due to reduced demand and virus-related disruption. The supply of several commodities is unlikely to catch up with demand due to years of limited investment amid falling prices, setting the scene for potential price inflation. Emerging markets, in particular, are vulnerable to rising inflation with tight monetary policy possibly needed to contain the risks: while this is not an immediate concern it is one to watch for late 2021 and early next year.

Emerging markets: reform is the real vaccine

According to the World Bank, countries affected by major epidemics such as SARS, MERS, Ebola, and Zika have seen a 6% decline in labour productivity and falls in investment of 11% five years after the event as lingering risk aversion dampened activity.

Covid-19 will likely have a more considerable impact on productivity due to its global spread, making structural reforms vital for emerging markets to improve long term growth prospects.

Figure 8. Productivity and epidemics

Chart showing productivity and epidemics

Source: World Bank, as at December 2020. Note: Bars show the estimated impacts of SARS (2002-2003), MERS (2012), Ebola (2014-2015), and Zika (2015-2016). Blue lines display the range of the estimates with 90 percentile significance. Swine flu (2009-2010), which coincided with the 2008-2009 global financial crisis, is excluded to limit possible confounding effects. The sample includes 116 economies: 30 advanced economies and 86 EMDEs.

Structural reforms also catalyse the supply-side improvements necessary to mitigate inflationary pressures. Reforms are essential as several emerging economies have vulnerabilities such as:

  • low import cover (Turkey);
  • high current account deficits (South Africa, Indonesia, and India);
  • high inflation (India and Turkey); and,
  • a high proportion of short-term foreign debt to forex reserves (Malaysia, South Africa, Turkey, and Chile).

Additionally, credit risk is high after rising state-owned enterprise (SOE) bond defaults in China while social uncertainty could become an issue around the Russian parliamentary elections in 2021.

Table 1. Emerging market vulnerability

FX reserves USD billion
Import Cover in months
Current Account (% of GDP)
Inflation (CPI YoY%)
Short Term Foreign Debt USD (Billion)
Short Term Foreign Debt as % of GDP
Short Term Foreign Debt as % of FX Reserves
ASIA (average)
China A.Shares
South Korea
LATAM (average)
EMEA (average)
South Africa

Source: Bloomberg, as at December 2020.

Strong earnings acceleration justifies EM growth prices; value not cheap but holds upside potential

EM value and growth sectors are respectively trading at more than 1.5-times and 3.5-times standard deviations away from the long term average.

Figure 9. EM value forward P/E

Chart showing EM value forward P/E

Source: Bloomberg, as at December 2020.

Figure 10. EM growth forward P/E

Chart showing EM growth forward P/E

Source: Bloomberg, as at December 2020.

Growth stocks have sustained high valuations on the back of ongoing earnings results while the still relatively strong value sector performance reflects a rebound in economic activity and earnings estimates. Earnings of EM growth shares are likely to outperform developed markets while trading at broadly similar multiples.

Figure 11. Earnings per share (EPS) growth estimates (%)

Chart showing earnings per share (EPS) growth estimates (%)

Source: Bloomberg, as at December 2020.

Since 2008 when EM value multiples have fallen from par to trading at approximately half that of the growth sector compared to the long-term average of 0.7-times.

According to analysts’ estimates, value sector earnings should rebound by about 50% in 2021 before moderating to 16% in 2022. Meanwhile, earnings for the growth sector, resilient in 2020 compared to value, are expected to increase substantially in 2021 and over 20% in 2022.

Interestingly, the projected earnings-per-share (EPS) differential of value compared to growth sectors is 0.7-times for 2021/22 (a valuation differential of 0.5-times), implying the potential for value to re-rate on a relative basis driven by the ongoing economic recovery and possible rising inflation.

Figure 12. Emerging markets value v growth valuation differential

Chart showing emerging markets value v growth valuation differential

Source: Bloomberg, as at December 2020.

Investment conclusion: structural opportunities coupled with value benefiting from long-term catalysts

Fiscal and monetary stimulus programmes across the world buoyed global markets in 2020 with encouraging Covid-19 vaccine trial results providing an end-of-year boost for investors.

Notwithstanding any fallout from the new UK variant of the virus, hopes of further fiscal stimulus and a roll-out of vaccines’ are likely to keep the markets excited in the near term.

In the medium term, although global economies have been improving recently, the outlook remains mixed. Significant risks remain including the potential for fiscal stimulus to disappoint or inflation overshooting expectations. Against the uncertain backdrop emerging markets need to pursue structural reforms to ensure sustainable growth.

On the Global Emerging Marekts team, we prefer structural drivers over chasing cyclical momentum. Alongside retaining a bias towards growth and quality, we believe that there is potential in select value sectors exposed to structural drivers such as financials (demand for credit, insurance), materials (low-carbon economy). However, we still believe that a number of megatrends – as listed below – constitute the most attractive investment opportunities.

5G, digitization, cloud, IoT, electrification, automation, rising financial penetration, a growing, and aspiring middle class driving consumption, and focus on reforms/infrastructure

By targeting structural trends investors can minimise the risks associated with a delay in either vaccine roll-out rates or their efficiencies, ineffective stimulus support and rising inflation expectations. At the same time, climate change poses an existential challenge to large parts of the world. An aging society with an inevitable shift to a lower-carbon economy indicates a slower, less resource-intensive world lies ahead of us.

Country allocation review

Valuations across most emerging markets reflect prospects of strong earnings growth. But there are a few exceptions to the positive mood, notably South Africa, Turkey, and Mexico, where valuations remain cheap relative to their respective histories and compared to the rest of EM Markets.

Regardless, in South Africa and Turkey the allure of a cheap valuation is tempered by macro vulnerabilities in those jurisdictions. Valuations looks fair in China, Indonesia, Chile, and Russia compared to earnings growth. Markets in Thailand, Taiwan, and Korea look relatively expensive but remain in line with the historical relationship to EM (in terms of standard deviation away from the long-term average). India is an outlier at over 2.9-times standard deviations above its long-term average, supported by an expectation of strong earnings bounce-backs. India, Mexico and Brazil offer the strongest earnings rebounds as last year earnings collapsed 60-70%, forming a low base in 2020.

Figure 13. EM valuation (standard devation) v EPS compound annual growth rate

Chart showing EM valuation (standard devation) v EPS compound annual growth rate

Source: Bloomberg, as at December 2020.

China: economic strength tempered by global and internal political tensions
Korea: set to benefit from secular drivers, improving world economy
Taiwan: a unique position in the global tech, semi-conductor supply chain
India: bottoming financial sector and reform boost growth potential
Indonesia: economy yet to fully recover from Covid-19, long-term prospects positive
Thailand: recovery hinges on tourism, structural issues cloud long-term growth
Russia: energy rebound underpins economy as geopolitics, internal barriers limit performance
Turkey: policy uncertainty weighs against rate hikes, cheap valuations
South Africa: significant structural challenges in cheapest EM market
Brazil: cyclical rebound hampered by weak domestic sector
Mexico: strong earnings recovery, sound economy, attractive valuations


Risk profile

  • This document does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
  • The value of investments and income from them may go down as well as up, and you may not get back the original amount invested.
  • Past performance is not a reliable indicator of future results and targets are not guaranteed.
  • Investments in emerging markets tend to be more volatile than those in mature markets and the value of an investment can move sharply down or up.

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