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Three Things We’re Thinking About Today
- Geopolitical risk returned to the forefront as border tensions between China and India heightened, with the latter imposing economic measures including banning 50 Chinese apps and canceling government contracts with Chinese contractors. Although India has also renewed efforts to limit imports from China, we believe this would be challenging in view of India’s dependency on Chinese end-products as well as raw materials/machinery for its manufacturing supply chain. While geopolitical headlines relating to China have created noise and near-term uncertainty in recent years, they are unlikely to derail China from its path to recovery, in our view. The latest stimulus measures, including sizable fiscal spending, announced at the National Party Congress in late May, should provide positive catalysts to the domestic recovery in the nearer term. The government did not set an explicit growth target for China’s economy for 2020 due to the high level of uncertainty around the pandemic and global situation. However, it emphasized that employment as well as social measures (protecting basic livelihood) will be key priorities this year. This implies growth support and continued measured and targeted policy stimulus—with room for further stimulus if necessary—consistent with the trend Chinese policymakers have set thus far.
- The COVID-19 pandemic continues to add momentum to the discussion on deglobalization. This term has many potential meanings. It could simply refer to the re-shoring of certain strategic businesses, a reduced reliance on foreign supply chains, or the creation and/or support of national champions. However, some portray it to mean something more material. For instance, the collapse of international trade agreements and the organizations and associations that oversee them. So far, there is little evidence to suggest the latter is the case. Our view is that not all countries are keen to disrupt existing trade relationships. In fact, many continue to seek renewed trade deals, deepening their integration with others. Recent trade agreements include that between the European Union (EU) and Mercosur, while pending trade agreements include those between the United States and the United Kingdom. There are many positive examples across the globe of the benefits of trade and its ability to create wealth and opportunities for countries. Over the period 2009-2018, for instance, South Korean exports of goods and services rose by close to 60%, helping to fuel a nearly 30% rise in per-capita net income.1
- As we continue to shift toward a knowledge-based global economy, we are seeing a rise in the importance of intangible assets. In fact, several emerging markets (EMs) are now leading in terms of innovation in areas such as e-commerce, e-learning, digital payments and mobile banking. We think this trend is likely to continue. For example, when the COVID-19 outbreak first occurred in China, one of the country’s leading after-school tutoring companies was able to convert all the learning courses they offered in physical learning centers across 100 cities to an online platform. Effectively, that meant two million students had been transitioned. We expect further acceleration in the penetration of online tutoring in China in the medium to long run. Another company commonly known for its e-commerce platform has diversified its business and expanded into new sectors over the years. During lockdown, the company gave free access to its communication app, which allowed 600,000 teachers to teach remotely. It also increased the number of live-streaming sessions on its e-commerce platforms while millions of people were confined to their homes in lockdown. In times of crisis, businesses often need to quickly adapt, which can lead to the adoption of new technologies. We have seen the COVID-19 pandemic accelerate technological developments across the globe—perhaps changing how we shop, learn and receive health care services permanently.
Outlook
We believe that the COVID-19 pandemic has highlighted the strengths of the emerging world, including social systems, governance, and in many cases, health care. We have also seen solid progress in terms of reforms over the last decade, both from a fiscal and corporate point of view. As a result, we are seeing the financial strength of emerging economies and EM corporate balance sheets proving to be a source of resilience through the crisis. We expect this to continue to be the case, especially in Asia.
As an example, at the onset of COVID-19, when the scale of the crisis was yet to be fully known, many investors believed that EMs like China would require a significant amount of fiscal and monetary stimulus to get back on track. While we have seen some stimulus across EMs, the biggest source of stimulus, both fiscal and monetary, has in fact come from the developed world, And, it’s been at unprecedented levels which far exceed what we saw in the global financial crisis, raising the question of how that stimulus is going to be eventually recovered and paid for. We are of the opinion that is going to be a real hindrance and could lead to some headwinds for the developed world, at least for a while.
In addition, when placed alongside the developments in the corporate arena—where we have seen the notion of leapfrogging models and innovation come to the fore again in a range of industries including technology, consumerism as well as financials—this gives us a lot of optimism in these companies and some of these economies.
Emerging Markets Key Trends and Developments
EM equities rebounded in the second quarter, though they lagged developed market stocks. A gradual rollback of coronavirus-induced lockdowns around the world, better-than-expected economic indicators, optimism around potential COVID-19 treatments, and widespread economic stimulus outweighed fears of second-wave outbreaks and renewed US-China tensions. EM currencies were generally stronger against the US dollar. The MSCI Emerging Markets Index increased 18.2% during the quarter, while the MSCI World Index returned 19.5%, both in US dollars.2
The Most Important Moves in Emerging Markets in the Second Quarter of 2020
Asian equities were buoyant as all markets recorded strong gains in the quarter. Taiwan’s effective control of the pandemic lent support to its stock market, which witnessed a rally in technology heavyweights. In India, the start of lockdown relaxations lifted hopes for the economy’s recovery and drove equities higher, notwithstanding a flare-up in India-China border tensions. Stocks in South Korea rose as the authorities deployed monetary and fiscal stimulus to shore up the economy, while investors shrugged off military threats from North Korea. Chinese equities advanced on encouraging economic data, though the market trailed most of its regional peers. A resurgence in US-China frictions and a new coronavirus outbreak in Beijing checked investor sentiment.
Latin American markets joined the global rebound, with improving mobility trends offering support as governments continued to ease distancing measures. Argentina, Brazil and Chile led regional performances, while equity prices in Colombia, Peru and Mexico—despite recording double-digit gains—lagged their peers. Continued monetary easing drove sentiment in Brazil, as its central bank cut the key interest rate during the quarter by 1.5% to a record low of 2.25%. Improving political cooperation and better-than-expected economic activity data for April further supported sentiment. In Mexico, weak macroeconomic data and a sovereign credit rating downgrade shadowed the central bank’s monetary easing efforts. An additional stimulus package boosted sentiment in Chile, while a sovereign credit rating downgrade in Peru held back market returns there.
Markets in the Europe, Middle East and Africa region recorded a solid quarter with South Africa, the Czech Republic and Poland leading the pack. Qatar and Egypt, however, lagged their regional peers. South African equities rallied as investors chose to overlook sovereign credit downgrades and focus on the gradual lifting of lockdown measures, better-than-expected first-quarter gross domestic product (GDP) data and implementation of fiscal and monetary easing measures. Russia’s benchmark index, driven by strong appreciation in the ruble, higher oil prices and easing quarantine measures, also recorded double-digit returns over the three-month period. Voters passed a constitutional referendum that allows President Vladimir Putin to seek two additional terms, effectively remaining in power until 2036.
Regional Outlook
Scroll over the map to view comments on the countries indicated and our sentiment.
Green = positive, Red = negative, Blue = neutral
The graphic reflects the views of Franklin Templeton Emerging Markets Equity regarding each region and are updated on a quarterly basis. All viewpoints reflect solely the views and opinions of Franklin Templeton Emerging Markets Equity. Not representative of an actual account or portfolio.
| ISO Code | Country | Sentiment Score | Opinion |
|---|---|---|---|
| CN | China | 0.5 | Economic conditions are expected to remain weak even if COVID-19 stabilizes, as it remains a global issue. However, government policy response will likely soften the impact. China will probably be the first to recover, barring the recent setback in Beijing. In general, we think China will most likely emerge stronger from this crisis. |
| IN | India | 0.5 | Long-term fundamentals including under-penetration, formalization of the economy and a stable government remain intact. However, the structurally constrained inflation and optionality of improving corporate earnings are offset by slowing economic growth and earnings cuts. |
| ID | Indonesia | 0 | The 12-month outlook remains uncertain. The government has been rushing to reopen the economy despite increasing COVID-19 cases and fatalities. COVID-19 containment efforts in Indonesia are among the weakest in the ASEAN region, while the government’s stimulus program rollout has also been slow and ineffective. |
| KR | South Korea | 0.5 | Macro indicators have been deteriorating due to the COVID-19 pandemic, but we expect the situation to normalize once it dissipates. However, concerns about government regulations are growing and geopolitical tension with North Korea is escalating, warranting close attention. |
| TH | Thailand | 0 | Although the near-term domestic outlook appears more positive than its ASEAN peers as the economy reopens, our overall outlook is negative due to: i) a weak global trade outlook; ii) a decline in tourist arrivals; iii) a lack of private investments to spur domestic consumption; iv) weak consumer sentiment as impact from the drought weighs on farmers’ income and results in a potential increase in unemployment. |
| TW | Taiwan | 0.5 | The near-term outlook remains negative as the COVID-19 outbreak has slowed the global economy. The crude-oil shock has also added to global uncertainty and volatility. Although the US and China reached a partial trade agreement, we expect trade issues between the two countries to continue. The Huawei ban also disrupts the supply chain, where many Taiwanese technology companies are engaged. The medium- to longer-term outlook, however, remains positive to us, given 5G deployment and the acceleration of production relocation from China. |
| PL | Poland | 0.5 | The European Commission forecasts the smallest GDP decline in 2020 among all EU members. While central bank effects to support the economy have been quite generous, structural headwinds including demographics and a lack of true reforms weigh on the country’s outlook. |
| CZ | Czech Republic | 0.5 | As an export-dependent economy, the current environment remains challenging. However, government policies could help support the economy during these difficult times. |
| HU | Hungary | 0 | The economy is highly integrated with the eurozone (and especially Germany, which is a major global exporter). An immediate recovery is unlikely in view of the weakness in the global economy. The Hungarian economy is expected to remain under pressure. |
| RU | Russia | 1 | In a stable oil price/ruble environment, companies should benefit from earnings revisions and improved dividend yields. The political situation should remain stable with the next presidential election scheduled for 2024. Macro risks, however, remain high due to volatile commodity prices, the US-China trade conflict and the possibility of additional US/EU sanctions. Overall, we maintain a positive view as historically low interest rates in Russia should increase local investment in the stock market. However, concerns about COVID-19 continue to impact market sentiment. |
| PE | Peru | 0.5 | Peru is a relatively open economy (by Latin American standards) (exports account for nearly a quarter of GDP), leveraged on metals and China, its main trading partner. This could help Peru to be among the first economies to benefit from the normalization of activity in China, compared to the lagging process to control the COVID-19 outbreak in the United States. Informal labor in Peru is very high, and this makes it vulnerable to flow restrictions as a result of the quarantine measures. However, Peru’s plans to lift lockdown restrictions across most of the country in early July should help improve the situation. |
| BR | Brazil | 0.5 | The COVID-19 pandemic is expected to have a lasting impact on Brazil’s economy. The speed and strength of recovery will depend on the government’s resumption of its ambitious economic reforms, which should provide the basis for higher long-term economic growth and a better business environment for companies. Record-low interest rates should likely continue to drive domestic flows to equities. |
| MX | Mexico | 0.5 | Mexico has an open economy (over a third of GDP) heavily exposed to the United States (over 70% of its exports go there). The length of disruptions from flow restrictions to contain the COVID-19 spread will determine the level of the slowdown. Additionally, Mexico has a large informal economy, which will suffer from restrictions to services impacted by quarantine. |
| QA | Qatar | 0.5 | Key risks include slowing economic growth, political conflict and deadlock, and continued weak investor appetite. |
| KW | Kuwait | 0.5 | Kuwait has a strong fiscal position but a delay in reform and issuance of debt law could erode government finances. Non-oil GDP is somewhat shielded, as the government employs most Kuwaitis. . |
| SA | Saudi Arabia | 0 | The outlook is challenging and remains anchored to a recovery in oil prices and developments related to COVID-19. Substantial foreign exchange reserves and PIF (public investment fund) assets provide some comfort. |
| AE | United Arab Emirates | 0.5 | We expect a challenging 12 months ahead, given impact from COVID-19 and low oil prices, although the UAE remains among the least dependent on oil and with the most successful fiscal reform track record. The property sector remains a risk, while we could see some stress on asset quality in the banking sector as well as entities related to the Dubai government. |
| EG | Egypt | 0.5 | We expect growth to remain positive and recover gradually, while discretionary spending could remain under pressure. We see receding inflation with little risk of rate increases and expect the currency to weaken slightly. |
| KE | Kenya | 0 | The outlook remains weak. |
| NG | Nigeria | 0 | The risk of further currency weakness remains high, while a weak political and macroeconomic environment creates a weak environment for stocks. |
| ZA | South Africa | 0 | The outlook remains muted and dependent on the government. 2020 is likely to be tougher than expected, with additional pressure from a weaker global backdrop and sentiment. |
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1. Source: The World Bank.
2. Source: MSCI. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging-market countries. The MSCI World Index captures large- and mid-cap performance across 23 developed markets. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Important data provider notices and terms available at www.franklintempletondatasources.com.