The term emerging markets is now more a matter of benchmark classification as opposed to some common fundamental reality. Emerging market fundamentals are about as dispersed as they have been for two decades, with the point of maximum fundamental correlation – such as the days of the BRICs – reached some time ago and now passed.
There are many reasons for this, but most notable is China’s industrialisation phase moving on, thus ending the commodity supercycle that, as a byproduct, created high economic correlation between China and major emerging market commodity producers. In addition, the developed world’s growth struggles since 2008 have also muted the secular export theme within the emerging world.
Rather than looking back hoping for the good-old correlated times to return, it is important to understand the dimensions of change across and within the emerging world in order to achieve investment success. While developed markets share relatively narrow economic growth characteristics – an absence of high growth being the common link – emerging markets offer a breadth of growth backdrops.
Russia and the Philippines are perhaps the most extreme examples. The Russian economy is currently defined by weak economic growth in the near term, in part given its heavy reliance on energy. It also has weak domestic consumption growth and a population that is aging at a rate not dissimilar to Japan. While energy prices will ebb and flow with the cycle, this latter point is an undeniable long-term headwind.
By contrast, the Philippines has very little in common with Russia – aside from a concession that both are linked by the very broad banner of emerging market ‘political risk’. This stems from both being led by deeply nationalist and externally controversial presidents – Putin and Duterte. However, this is where the comparison stops. Why? This is because the Philippine economy is much less cyclically oriented, given its domestic consumption-oriented growth nature, as well as its scarcity of natural resources. The Philippines also has the luxury of being one of the most demographically advantaged economies in the world.
The contrasts go on and on. Take Brazil and South Africa and the lack of meaningful structural reform in recent years, as political inertia has dominated the need to change with the economic times. Then compare these with India and Indonesia, where governments are making real attempts to positively reform, even in the midst of an uncertain global economy.
While India’s Prime Minister Narendra Modi has faced challenges and scepticism, structural reform sits at the heart of the rebound in Indian equity prices so far in 2017, as the withdrawal and replacement of large denomination bank notes, aimed at ensuring the integrity of India’s monetary base, has worked its way through the economy without the ‘crisis’ predicted by many. Indeed, with the process largely complete and with a nationwide tax simplification programme also about to be implemented, India’s loan growth and economic activity looks well set to reaccelerate this year. We have been overweight and adding to our holdings in India, which is composed predominantly of banks and consumer stocks.
While the market loves badges – ‘fragile five’ being one, the ‘BRICs’ another – it is crucial to distinguish between the complex reality of emerging markets and the catch-all summaries used to define the extremes of good and bad. For those wishing further evidence on this point, the change in growth and inflation and the twin deficits of the fragile five from three years ago should serve as evidence that no acronym, no matter how catchy, defines a complex reality – over the long term at least.
Scott Berg is portfolio manager of the T Rowe Price Global Growth Equity fund