Posted: 06/07/2019 by Fidelity Viewpoints

For long-term investors, volatility matters less than emerging markets’ future prospects.

Key Takeaways

• Trade wars have raised investors’ concerns about emerging markets (EM), but many EMs still represent attractive long-term investment opportunities.
• Emerging markets’ recent growth has been fueled by commodity exports but their future growth will be fueled by consumer demand from their own citizens.
• Investors should understand that all emerging markets are not created equal, so careful security selection is important.

Trade tensions between the United States and China have been helping to roil markets since early May when the Trump administration put a 25% tariff on $200 billion worth of Chinese imports and threatened to impose tariffs on an additional $325 billion. Among the assets that have been caught in the crossfire between the world’s two largest economies are the stocks of companies from emerging-market nations whose prices have suffered as investors worry over the global trade environment.

Many of these countries’ economies grew rapidly over the past several decades as global trade expanded and they exported commodities to China and the United States. Now with trade tensions increasing and global economic growth slowing, investors may wonder if EMs’ best days are behind them. Not necessarily, says Fidelity portfolio manager Sammy Simnegar. “I think it’s wrong to look at emerging markets through the lens of the last cycle when commodity prices were high and the dollar was weak,” he says. But while he believes that those days of commodity-driven growth are over, he sees opportunities in some emerging markets for other reasons.

More happening than trade wars

Simnegar cautions investors against viewing the current trade dispute as a passing phase during which worrisome headlines may prompt markets to sell off and create buying opportunities in mispriced stocks. Instead, he says investors need to understand the shift toward protectionist trade policies as only one challenge facing many EMs.

More significant is what he calls the end of the “commodity supercycle,” a long period of seemingly insatiable demand—largely from China—for raw materials such as oil, iron ore, and copper. That demand was the result of China’s relentless drive to build factories, ports, roads, and even entire new cities as it became a global power. Now that China has largely built out its infrastructure and is restructuring its economy toward consumer spending, the double-digit annual increases in commodity demand and prices that enriched many EMs are unlikely to resume.

Security selection matters

With the “commodity supercycle” at an end, the countries that are grouped within the same emerging-market indexes may present very different opportunities—and risks—to investors. Some emerging markets have, well, emerged more than others. For example, South Korea and Taiwan’s economies, financial markets, and governments today closely resemble those of developed markets. Meanwhile, other EMs such as South Africa and Brazil have suffered from corruption and a trend toward politically motivated meddling in the management of companies.

Simnegar says prospective investors should pay attention to the variegated nature of EM. He sees the most attractive opportunities in countries such as India that have outgrown their previous roles as exporters and are growing robust consumer economies of their own.

“Middle-class growth is fueling myriad long-term opportunities in emerging markets,” he says. He notes that India, for example, now boasts a greater number of households with disposable income of more than $10,000 than does Japan. The growth of these domestic consumer markets is a key reason why Fidelity’s Asset Allocation Research Team forecasts EMs to grow to comprise about 50% of global GDP in twenty years, compared with about 40% now and 25% twenty years ago.

How and when to invest

Investors who want exposure to the long-term growth potential provided by EM consumers that an allocation to EM can offer should consider whether they also want exposure to some of the less attractive assets that are grouped together with the brighter lights within emerging markets’ indexes.

Simnegar says actively managed mutual funds that practice careful security selection and rigorous research may be preferable to passive strategies that reflect the performance of assets whose quality varies widely. When assessing EM stocks, Simnegar evaluates companies with what he calls the “Three Bs,” which are barriers to entry, strong brands, and best-in-class management teams. He says that overall, he has found these companies largely in the industrials sector, as well as in consumer technology and health care.

Simnegar also recommends investors avoid trying to “time the market” to take advantage of buying opportunities created by trade turmoil. Indeed, investors should consider that emerging-market volatility may be unlikely to subside completely even after the United States and China settle their present dispute. Data from the World Trade Organization suggest that the U.S.-China conflict is only part of a broader reset of trade policy around the world. From 2017 to 2018, WTO member countries imposed 137 new tariffs, taxes, or duties on $588.3 billion worth of global trade, more than seven times the amount in 2016. Greater trade tension could produce ongoing volatility and vex those who try to time markets rather than simply investing on an ongoing basis for the long term.

Finding emerging-market investing ideas

Despite trade-related headwinds and lower commodity prices, Simnegar believes carefully selected emerging-market assets can provide diversification and long-term growth in a portfolio.

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Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for investments that focus on a single country or region.

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