What does sluggish emerging market growth mean for investors?

We recently upgraded our forecast for global economic growth to 5.9%, for this year, from 5.2% previously. However, this move was skewed towards developed markets and encompassed only a small increase to our projection for output in the emerging world.

Indeed, we expect the gap between emerging market (EM) GDP growth and that in the rest of the world over the next eighteen months to be the narrowest since the turn of the millennium.

What does sluggish growth mean for EM assets?

Investing in EM is not only about gaining exposure to relatively fast economic growth. But as the chart below shows, growth has historically been an important factor in the relative performance of assets such as equities.


Accordingly, even though EM external vulnerabilities are relatively contained, our expectation for sluggish growth at a time when the Federal Reserve is set to turn more hawkish instinctively feels like a tough backdrop for investors in the emerging world to navigate.

However, it is wrong to simply think about EM as a single asset class and the macroeconomic outlook still presents ample opportunities for investors.

Asia is still in the driving seat…

In the very near term, Asian manufacturers remain in the driving seat. Indeed, we nudged up our forecast for GDP growth in China this year to 9.2%, from 9% previously. This is based on the premise that while the reopening of the global economy is likely to skew strong demand towards the services sector, at least some will find its way into goods.

Early signs of a second, mini inventory cycle in recent manufacturing PMIs from China suggest this is beginning to unfold. Output has so far lagged behind, which may be a sign of supply bottlenecks. However, the strong demand backdrop should support activity and this is likely to filter through to other, export-dependent markets across Asia and aid the performance of markets in the region.


Nonetheless, the bigger picture remains that the long term leading indicators of China’s domestic business cycle have been turning for some time. Growth in real M1 peaked in November of last year while the credit impulse has been declining since October. Both give a good indication of the future direction of growth with a lag of about nine months, which implies that evidence of a cyclical slowdown in China should become visible from Q3 onwards.

This will be a trickier environment for cyclical markets such as equities and commodities, but should present opportunities in local fixed income markets which continue to steadily open to foreign investors.

Earlier this year, we argued that the EM growth baton would pass from Asia to other regions and this is beginning to happen.

…but the growth baton is now being handed to other EM regions

Brazil’s economy was much more resilient in the face of a second wave of Covid infections in the first quarter, and support from vastly improved terms of trade should ensure good momentum in the months ahead. Local markets have begun to show improved performance in recent months, in line with our expectations. And while the electoral calendar remains a concern, the short term outlook is positive.

Mexico’s economy is also starting to perk up having previously lagged behind other parts of EM. In particular, activity in the manufacturing sector is on an upward trajectory as demand from the neighbouring US, which is the destination for the vast majority of Mexico’s exports, goes through the roof. As the chart below illustrates, there has historically been a very good correlation between movements in the US composite PMI – which hit an all-time high in May – and the performance of Mexican manufacturing. This is likely to be positive for the performance of local assets.


Finally, the roll-out of Covid 19 vaccines and the subsequent reopening of economies is another theme likely to drive markets.

So while the external backdrop may become more challenging in the months ahead, investors that dig beyond the headlines are likely to find opportunities.

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