While the coronavirus originated in China, Chinese equities have paradoxically been among this year’s winners. China has also contributed to supporting emerging markets in a broader sense.
“Emerging market countries are generally sensitive to economic activity in China, not least the other Asian countries. If things go well in China, it tends to have a positive knock-on effect on a string of other countries that China trades with – and by 2020 standards we have recently seen a relatively strong economic performance by China, which is thus a positive factor for emerging market equities. We expect this to continue, at least in the short term,” explains Danske Bank’s investment strategist, Lars Skovgaard Andersen.
China’s uncompromising approach
One of the reasons for China’s strong performance despite the corona crisis is that the Chinese authorities are able to act more resolutely to support the economy than their democratic Western counterparts, where for better or worse the political decision-making process is more protracted.
“Furthermore, the Chinese have been extremely effective at containing the virus – again because the authorities have been more heavy handed about imposing restrictions than most other places in the world,” says Lars Skovgaard Andersen.
This uncompromising approach to the coronavirus by China has contributed to expectations that emerging market companies will experience a noticeably smaller decline in earnings per share (EPS) in 2020 than companies in developed markets like Europe and the US.
“Looking ahead, we expect an economic upswing to gain traction in the coming year following the massive beating the global economy has endured so far in 2020. This should also be positive for emerging market companies, which are usually quite cyclical in nature – in other words, they typically perform best during periods of economic growth,” says the investment strategist.
TikTok dispute not so worrying
Moreover, Lars Skovgaard Andersen estimates emerging market equities are still attractively valued.
“Looking more specifically at Asian equities, they also offer a high share of IT and communication service companies, which are the sectors where we currently see the most attractive return potential,” he says.
Nevertheless, our investment strategist stresses that the ongoing US-China trade war constitutes a significant risk that could trigger periods of price volatility if the situation deteriorates. In particular, Chinese tech companies could be held hostage by the trade war, which is very much motivated by future world domination in the tech sector, where the US feels its leading position is under threat by China.
Moreover, Donald Trump likely feels an even greater need to make his mark ahead of the US presidential elections in November, which could further escalate the conflict between the US and China. We can see this at the moment with the popular Chinese video app, TikTok, which Donald Trump has threatened to ban in the US due to fears it could give the Chinese authorities access to data on US users.
“In the short term, however, we are not that concerned about these disputes, as they are currently mostly just noise and have minimal economic significance,” says Lars Skovgaard Andersen.
Oil price and exchange rates positive factors
Falling oil prices have been an important theme for emerging markets this year, but this has been positive overall for major Asian economies like China and India, who are net importers of oil. The biggest losers are to be found elsewhere among emerging markets, for example Russia and Brazil.
Exchange rates and interest rates are other important variables. The US dollar (USD) has weakened noticeably of late, which makes servicing USD-denominated debt cheaper for emerging market companies and governments. We expect the very accommodative monetary policy of the US central bank, the Fed, will help keep the dollar weak.
Hence, the overall picture at the moment is of a number of factors pointing in the right direction for emerging markets – but don’t forget that emerging market equities are by definition associated with a high risk.