Outlook 2020: Emerging market equities
- We expect an acceleration in economic growth for emerging markets (EM) in 2020.
- There is potential for moderate US dollar weakness; this generally equates to EM currency appreciation and is positive both for financial conditions in EM, and for local earnings translation into dollars.
- Uncertainty stemming from the US-China trade conflict, soft economic growth in China and global challenges are likely to persist.
The world is currently in a manufacturing recession. The main drivers have been (i) the materially negative credit impulse in China in 2017 and 2018, (ii) monetary tightening from developed market central banks in 2018 and early 2019, (iii) US dollar strength, and (iv) escalation in the US-China trade conflict, which has impacted trade flows and driven a deterioration in corporate confidence.
Why these drivers should improve or stabilise in 2020
i) China credit impulse: As chart 1 illustrates, the China credit impulse, which represents the change in new credit as a percentage of GDP, stabilised and improved in the second half of 2018 and in 2019. Meanwhile, other stimulus has been applied, both monetary and fiscal.
We anticipate that stimulus will remain moderate next year, primarily due to the existing level of debt and the scale of increase in that debt over the past decade. Macroeconomic data in China continues to be weak. But we expect economic growth to be relatively stable in 2020, as a function of ongoing stimulus provision, following a marked drop in economic activity through the second half of 2018 into the first half of 2019.
Source: Refinitiv, Schroders Economics Group, 23 October 2019. Historical trends are not indicative of future trends.
ii) Monetary policy: Developed market central banks pivoted to a more accommodative policy stance in mid 2019. The US Federal Reserve (Fed) made three 25bps cuts to its key policy rate in the second half of the year, and shifted from quantitative tightening (QT), or balance sheet normalisation, to material liquidity provision. The European Central Bank restarted its quantitative easing (QE) programme in November, with asset purchases of €20 billion per month. Developed market monetary easing has facilitated broad-based monetary easing by EM central banks, as chart 2 indicates. Furthermore, certain EM are likely to see fiscal loosening in 2020, relative to 2019.
Source: Refinitiv, Schroders Economics Group. 31 October 2019.
iii) The dollar: There is potential for US dollar weakness in the next 12-months. The dollar is expensive and we expect the growth differential between the US and Europe/EM to improve in 2020. Dollar depreciation generally equates to EM local currency appreciation and is positive both for financial conditions in EM and for local earnings translation into dollars.
iv) US-China trade conflict: It is difficult to predict the timing, scope and sustainability of any settlement in the US-China trade dispute. However, ongoing negotiations suggest that both sides are interested in avoiding further escalation.
On a longer term basis, tensions look likely to persist. This is partly due to an increasing populist reaction in developed markets from those who have been the losers from globalisation; but also due to China’s ongoing development as an economic and military superpower, and the extent to which the global balance of power is evolving. Hence in the near-term, we do not see ongoing escalation in trade tension and see some scope for partial resolution. But corporate investment may remain relatively muted as a function of longer term policy uncertainty.
What does this mean for emerging market growth?
All this should be supportive of EM economic growth in 2020. Schroders’ Emerging Market Economist, Craig Botham expects EM growth to accelerate from 4.1% in 2019 to 4.5% in 2020.
We also see potential for a positive industrial cycle moving through 2020. The current environment has driven a deterioration in corporate investment and trade and may have driven inventory correction. This industrial cycle may be enhanced by the uplift in growth driven by monetary and fiscal loosening, a moderately weaker dollar and a partial de-escalation in the trade conflict.
This cyclical upturn would likely support an improving growth differential for Europe and EM relative to the US, which should be supportive of dollar weakening. Fiscal attitudes in developed markets, especially in Germany, also bear watching.
Are EM valuations attractive?
2019 has seen materially negative earnings per share revisions and, at +3% year-on-year, earnings growth has underperformed the market return of 10.2% year-to-date (29 November), as measured by the MSCI Emerging Markets Index.
The earnings outlook remains relatively uncertain. However, on the basis of our economic outlook, earnings could deliver in line with consensus expectations, currently +12%, in 2020 and valuations for EM remain relatively attractive, especially in some cyclical areas of the market.
The balance of risks looks favourable for EM equities in 2020
In our view, the balance of risks looks to be tilted in favour of EM, in terms of the trade conflict and potential dollar weakness. We see EM growth improving in 2020 as a function of monetary, and in certain cases fiscal, easing and there is scope for a moderate industrial cycle. Valuations are reasonable and earnings expectations for 2020 could be met.
On the other hand, the relationship between the US and China remains uncertain and Chinese economic growth remains soft. Furthermore, the global environment remains one of excess debt and secular stagnation, with underlying growth slow; and markets in general have had a strong year as a function of the pivot to policy easing. We also believe that the recovery in growth will be moderate. Hence we are positive on the outlook for EM equities in 2020, albeit cautiously.
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