Investors have outdated perceptions about some of the fastest-growing economies in the world, says Franklin Templeton portfolio manager
Trends in emerging markets have investors reconsidering opportunities and reassessing risk.
When the first 10 emerging market countries were bundled together 30 years ago, they produced commodities, low-cost manufacturing, and not much else, says Franklin Templeton in an ‘Emerging Markets Insights’ report. The guidebook was simple: produce locally and sell abroad. Countries with access to oil, precious metals, and huge workforces thrived in the category’s early days – but their fortunes were tied to the developed world.
Things have changed. Today’s 24 emerging market countries offer so much more than energy and raw materials. And spending by the growing middle class is making emerging markets more independent.
So today, emerging markets are more than commodities, with shopping and technology as the new drivers of growth.
“A significant part of the ‘next billion’ of middle-class consumers will come from emerging markets, which will drive both consumption growth and premiumization,” says Chetan Sehgal, Senior Managing Director, Portfolio Manager, Franklin Templeton Emerging Markets Equity. “Emergence of online platforms and supporting infrastructure of logistics and payments have enabled growth and penetration of both goods and services consumption in many of the emerging markets. This has created growing opportunities across e-commerce, logistics, and financial services.”
As well, “emerging markets dominate segments of the technology and renewable energy industries including semiconductors and solar panels as well as Information Technology (IT) services. Demand for semiconductors is forecast to grow in the coming years, driven by demand for processing power to drive artificial intelligence applications and the internet-of-things (IoT).
“Renewable energy demand is driven by national commitments to reduce carbon emissions. IT service providers are climbing the value-added ladder as companies continue to look for more efficient ways to manage their technology needs. Technology advancements in renewable energy should lower the cost of generating electricity for many of the thermal energy dependent emerging market economies which should further support their growth.”
Investor attention switches to energy prices
China’s economic reopening is proceeding swiftly, despite the spike in COVID-19 cases in early January, says the report. Investor attention has recently switched to the reopening’s impact on energy prices. In contrast to Europe, China experienced a bitterly cold winter, with average temperatures 15ºF below average for the month of January. This is increasing demand for natural gas, the majority of which China imports from overseas. Liquid natural gas (LNG) prices in Asia and Europe have not yet reacted to the frigid weather in China, as Europe is experiencing temperatures on average 15ºF above average over the same period. However, if this were to change, LNG prices could rise, reigniting global inflation concerns and limiting China’s room for fiscal manoeuvring given gas subsidies provided to households.
Sehgal says China’s economic recovery is slower than the market’s initial expectation due to several reasons, including:
- The lengthy time period Covid-19 restrictions were in place has undermined confidence to a greater degree than expected.
- Geopolitical changes during and post Covid-19, in particular US/China relations.
- Policy environment changes which impacted confidence of private sector.
- Contagion from the weakness in the property sector on credit demand, and leverage in the system.
- Demographic challenges, including a falling birth rate, which has been accentuated by Covid-19.
“While the economic recovery has been slower than expected, the move towards greener energy, comprising electric vehicles, solar, and battery storage, has been accelerating,” he says. “This trend combined with the slowdown in property construction in China will ultimately impact oil consumption. Also, travel has not fully resumed in China.
“At Franklin Templeton we are mindful of these factors in making investment decisions. Nevertheless, we are bottom-up stock pickers and see opportunities in the market focused on our core themes of consumption, the electrification of transportation, and renewable energy.”
Markets pivot toward growth
January witnessed a dramatic shift in the performance of growth stocks, with the MSCI Emerging Markets Growth Index posting double-digit returns. Value stocks witnessed positive performance but lagged behind. This is a reversal of the 2022 performance trend, wherein value stocks performed better than growth stocks as rising interest rates undermined the outlook for the latter. Looking ahead, the likelihood of a continuation of this January’s trend will likely be dependent on the direction of interest rates and the US dollar, among other factors.
“Many sectors in emerging markets which were once considered growth are no longer growing as fast,” says Sehgal. “New industry groups are emerging, including electric vehicles and batteries, which are growing rapidly but coming from a low base.
“The definition of what constitutes growth in the market keeps changing and investors must keep this in mind. Internally, we look at companies rather than ab initio to make distinctions between growth and value.”
Emerging markets earnings outlook
Franklin Templeton’s report says that consensus expectations are for a recovery in emerging market earnings in 2023, following a sharp decline last year. China’s reopening and economic recovery is expected to drive earnings, particularly in the financials and consumer discretionary sectors. High interest rates typically benefit banks, with a recovery in consumer technology business prospects looking likely, including e-commerce.
Emerging markets have come a long way since Franklin Templeton launched the first fund of its kind over 30 years ago – but it says many investors have outdated perceptions. The implications are serious. Underestimating these countries means overlooking some of the fastest-growing economies in the world.