A year has now passed since the correction of March 2020, as markets first appreciated the implications of a global pandemic. The last 12 months have seen more disruption than entire decades in ordinary times. Emerging markets, led by Asia, have remained relatively resilient, having successfully adapted to or suppressed the virus. By contrast, a return to economic normality in the West is dependent almost wholly on vaccines. While we are seeing rapid progress with vaccinations in the United States and United Kingdom, Europe remains far behind amid continued lockdowns and economic stagnation.
A Year On
Looking back on our prior outlooks, we highlight some key points:
- At the early stages of the pandemic, we emphasized China’s resilience—borne of drastic policy measures—which suggested even at an early stage that of large economies, China could ultimately be among the least affected by COVID-19.
- We saw far greater risks associated with demand destruction in the West and related liquidity and corporate stress driving a deflationary shock.
- While the massive monetary and fiscal packages unveiled in developed markets globally were greeted with optimism, we harbored doubts whether this would translate into the V-shaped recovery we expected in China.
- This caution hinged on whether developed markets would be able to replicate several factors shown to successfully drive containment. These included decisive policymaking paired with effective execution, economic resilience supported by digitalization, and social cohesion.
The World Today
Many countries in the West failed on the factors outlined above, albeit the extent to which we would see divergence with the more successful emerging Asian economies has taken us by surprise. This gulf in performance was evident across health outcomes, economic impact, partisan politics and social unrest—in turn, reinforcing the spread of the virus.
With continued weakness in developed markets, we have seen a continuance of unprecedented fiscal and monetary stimulus. In the United States, the long-term implications for debt service, incipient inflation and currency debasement remain unaddressed. In Europe, the longer lockdowns are extended, the greater the risk that temporary economic weakness translates into structural stagnation.
We continue to hold our views of a year ago, and believe the structural underpinnings of emerging markets’ resilience have been evidenced by the stark contrast with developed markets over this period.
China
It is striking that while China was the only major economy to show reasonable growth during 2020, and with an ongoing strong recovery, policymakers have set a more cautious growth target for 2021 of 6% against International Monetary Fund forecasts of 8%.1 In addition, for the first time, no longer- term average growth target was set. This was paired with greater emphasis on environmental and social reforms and new clean technologies—a “greening” of the economy. These measures signal the government’s broader push to a more sustainable and higher quality of growth for the long term.
China’s fiscal and monetary stimulus during the pandemic was far more measured than in the West; previous periods of overheating in real estate and shadow lending have driven an innate caution. We are now accordingly seeing a greater balance in China between economic recovery and policy leeway—a “Goldilocks” environment in which the government has greater flexibility to respond to economic developments. With any slowing of the economy, we wouldn’t be surprised to see policy loosening.
We believe we’ve passed the nadir in China-US relations, though tensions will remain elevated. After years of aggressive trade policy, the US trade deficit continues to reach all-time highs. Rather than a futile focus on trade, we believe the United States would benefit more from domestic reforms, infrastructure investment and advancing digitalization in its economy.
Portfolio Implications
The concept of a world-leading emerging-market company has evolved from an aspiration to a reality over the last decade—a trend reinforced during the pandemic.
Taiwanese and South Korean semiconductor firms dominate the global industry with their strong manufacturing capabilities, especially in cutting-edge semiconductor chips. Moreover, their clout has generated the cash for them to ramp up investments and widen their competitive advantages amid booming demand for chips from high-performance computing, bitcoin, auto, and other businesses. By comparison, Western semiconductor firms have struggled to keep up, whether in innovation or capital expenditure.
South Korean companies have also spearheaded the development of electric vehicle batteries, which have achieved greater penetration worldwide on the back of policy support and technology advancements. In China, biotechnology firms are developing innovative treatments for cancer and other major diseases and have won the confidence of global pharmaceutical groups in licensing these new drugs. India’s internet space, which has been under-represented in stock markets, also offers huge potential, in our view.
Taken together, evidence of emerging market companies scaling the value chain has increased, and we see durable growth characteristics in many of these firms. We expect a rising number of high-quality companies to emerge as various industries continue to develop and consolidate.
From the height of the pandemic through to the current early stage of recovery, our conviction in the growing structural advantages of emerging markets, led by key Asian economies, has only strengthened as the evidence has accumulated. Exemplifying this post COVID-19, China is now on track to become the world’s largest economy before the end of the decade. We believe this trend, which the COVID-19-led divide in performance over the last year reinforced, will continue to have positive implications for portfolio allocations to emerging markets, led by China, for years to come.
What Are the Risks?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.
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1. Source: IMF World Economic Outlook, January 2021. There is no assurance that any estimate, forecast or projection will be realized.
