Understand emerging markets opportunities and the American Century advantage.
By Nathan Chaudoin - September 2018
Global trade wars, higher U.S. interest rates, and a stronger U.S. dollar (USD) combined to send emerging markets (EM) toward bear market territory since January 2018. Political issues, including the ongoing discord between the U.S. and Turkey, have led to a precipitous drop in the Turkish lira. Currencies in Argentina and Brazil have also slipped. Though the reasons for each currency decline are unique, they have awakened concerns of contagion and a potential region-wide crisis reminiscent of the Asian currency crisis in the late 1990s. However, current conditions are distinctly different than those that sparked the currency meltdown of two decades ago.
Macroeconomic conditions and news headlines, not fundamentals, have driven recent EM performance. We don’t believe emerging markets should be viewed as a single homogeneous region that moves in unison. EM is a collection of independent markets, each with its own positive and negative characteristics that should be considered on individual fundamentals. We think investors would be well-served to view current conditions as short-term difficulties and remain focused on the longer-term positive outlook for EM.
Investor concerns about U.S. Federal Reserve (Fed) actions to normalize interest rates and a stronger U.S. dollar have combined with EM-specific challenges largely unexpected by the markets. These unexpected issues include the Trump Administration’s imposition of sanctions and tariffs and adverse political changes in some EM countries.
President Donald Trump’s expansion of tariffs on Chinese imports has been the most prominent driver of EM asset price underperformance in 2018. Chinese economic data has slowed as investors try to determine the ultimate impact of an escalating trade conflict on the Chinese economy. The administration’s imposition of incremental sanctions against Russia and its threat of sanctions against South Africa have further pressured EM markets.
The economic issues pressuring the Turkish lira result from questionable government policies. President Recep Tayyip Erdogan recently named his son-in-law as finance minister, leading to general concerns about the independence of the central bank and monetary policy. The ensuing decision not to increase interest rates to tame inflation, and instead to continue to fuel economic growth, drove down the lira swiftly in August. Turkey, however, is an isolated case and a minor player on the EM scene. It accounts for about 0.5% of the MSCI Emerging Markets Index and less than 1% of our EM portfolios.
It’s true that some EM nations have suffered on contagion fears. Argentina is undergoing an economic contraction partially driven by a drought. In addition, investors are concerned about the nation’s ability to make payments on dollar-denominated International Monetary Fund loans as the Argentine peso continues to weaken versus the USD.
Populist movements have also raised uncertainty, most notably the election of the socialist presidential candidate in Mexico. A similar situation could be arising in Brazil, where many investors remain on the sidelines awaiting the outcome of the upcoming presidential election. Recent opinion polls suggest that growing populist sentiment could complicate the environment there as well.
Trade. Global markets appear to have taken the ongoing trade conflicts in stride; many markets are currently at or near all-time highs. However, investors are understandably concerned about the potential effects that a prolonged trade war will have on China. We anticipate a soft landing as the government moves toward policy easing and deleveraging, intended to protect the economy from the potential negative impact of further trade war escalation. It is also encouraging that plans are being made for additional high-level trade policy talks later this year. The fact that the U.S. appears to have a trade deal in place with Mexico and is holding talks with Canada has mollified markets somewhat.
Interest rates. We don’t expect additional U.S. Fed rate hikes this year and next to significantly hamper EM performance as long as they are well-telegraphed.
Strong USD. Most EM countries appear better positioned than in recent history to withstand the effects of a dollar rally due to stronger domestic demand, muted inflation, and improved current account balances.
We think the long-term case for EM remains strong. Inflation is contained, reforms are in place, valuations remain attractive relative to developed markets, double-digit earnings growth is supported by above-trend global expansion, and gross domestic product growth rate differentials are widening. A moderating USD rally should also support EM equities, which tend to have an inverse correlation to the dollar.
September 2018: Notes from the Global Growth Equity Desk
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Material presented has been derived from industry sources considered to be reliable, but their accuracy and completeness cannot be guaranteed. Past performance is no guarantee of future results. This information is not intended to serve as investment advice.
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