Emerging Markets Insights

Expectations of Economic Normalization in 2021 Drove Confidence in Emerging Markets in the Final Quarter of 2020.

Franklin Templeton Emerging Markets Equity

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Three Things We're Thinking About Today

  1. Although the Chinese market lagged its emerging market (EM) counterparts in the final quarter of 2020, Chinese equities were among the leading outperformers for 2020. Geopolitical tension between China and the United States remains a key headwind that is likely to persist under President-elect Joe Biden’s administration, though we could see a shift to a more constructive tone. The US Department of Defense (DoD), however, recently added a number of Chinese companies to a list of those deemed to have some military connection. The executive order prevents US investors from holding any companies on the list, starting in late 2021. Although business operations should not be directly impacted by the ban, stock prices will likely be subject to some near-term volatility as a result of some forced selling. China appears to be the only major economy with gross domestic product (GDP) growth in 2020, underpinned by a diversified domestic economy driven by innovation and digitalization. Although regulatory tightening in the internet sector has raised some concerns over the short term, it could lower industry risk in the longer term. We continue to see the emergence of high-quality companies that are well-placed to benefit from ongoing market consolidation and booming domestic consumption.

  2. India has seen surging COVID-19 infections, but with mortality having been contained, economic reopening has continued. Although the disruption of traditional business models has weighed on some companies, we expect to see a positive impact on Indian technology service providers. The information technology (IT) services sector has been largely ignored over the last few years due to slowing growth and margin pressures, but both higher client traction as well as structural cost saving initiatives have offered support. As India embarks upon indigenization and import substitution, the resurgence of manufacturing activity, as well as global efforts to diversify supply chains, could drive demand across a range of product categories including electronics, defense, automobile parts and pharmaceuticals. Normalization of credit stress on the back of falling interest rates and improving liquidity should have a positive impact on banks, an area where we maintain a positive outlook. Meanwhile, negative real rates in India will provide very significant support for the economy and markets going forward.

  3. Brazil, despite the political noise, has continued to focus on important economic reforms that are leading to a structural downward shift away from its historically high real interest rate. The central bank has also cut its policy interest rate to a record low, which reduces the cost of renegotiating or restructuring loans, and could be a catalyst for longer-term credit growth. Credit penetration in Brazil is far below many other markets, signaling room to head higher in the coming years; we think this supports prospects for the financial sector. More broadly, negative real rates will provide structural support to Brazil’s growth outlook. We are also witnessing a long-term trend of “equitization” of investments that benefits participants in the financial services industry. Challenges remain in Brazil, however, including rising debt levels as a result of stimulus measures, paired with uncertainty surrounding continued economic reforms amid a politically fragmented environment. This may, in turn, place upward pressure on longer-term interest rates. The planned end of emergency aid in place to support those impacted by COVID-19 lockdown measures could also impact economic recovery.

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WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. 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. 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. Smaller and newer companies can be particularly sensitive to changing economic conditions. Their growth prospects are less certain than those of larger, more established companies, and they can be volatile.