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Emerging markets in the spotlight

Dec 16, 2020
  • BlackRock

Insights from BII’s 2021 Outlook and the importance of EM

In our 2021 Institutional Sentiment survey of U.S. and Canadian investors, emerging markets were viewed as the asset class offering the best opportunities in both equity and debt in 2021.1 Likewise, the BlackRock Investment Institute came out with broadly favorable views of EM in its 2021 Outlook. To help investors understand why we’re positive on emerging markets, and where we see the best opportunities, BlackRock’s Chief Client Officer Mark McCombe sat down with our leading EM investors and strategists for a broad-reaching conversation.

Mark was joined by Mike Pyle, Global Chief Investment Strategist for the BlackRock Investment Institute; Jeff Shen, Co-CIO of Active Equity and Co-Head of Systematic Active Equity; Gordon Fraser, Co-Head of Global Emerging Markets Equities; and Sergio Trigo Paz, Head of Emerging Markets Fixed Income.  Highlights of their discussion are below, and a full replay can be viewed here.

BII’s 2021 outlook is constructive on emerging markets, and so are the respondents to our flash survey. What makes you bullish?

We're looking for cyclical exposures with upside in 2021, and we think emerging markets will benefit from several tailwinds. Broadly speaking, the change in tone from the new administration in Washington should be a welcome respite from the unpredictability and volatility of the past four years. That boost in sentiment is going to be true across the board, but we believe it will be especially important for emerging markets.

We also see the outlook for the U.S. dollar as supportive of EM assets. We're positive on global risk in 2021, which we think is consistent with a somewhat weaker dollar. And the narrowing of the interest rate gap between the U.S. and the rest of the world also points to a weaker dollar, which tends to be quite good for emerging assets.

Regionally, when we look at emerging Asia, we see that the public health response has been extremely robust across a range of different economies, and that has left them well-positioned for the near term.  Over the longer term, we think that Asia, particularly East Asia, is going to be one of the most important poles of global growth alongside the United States.

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We're looking for cyclical exposures with upside in 2021, and we think emerging markets will benefit from several tailwinds.

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Mike Pyle Global Chief Investment Strategist, BlackRock Investment Institute

How have EMs weathered the storm this year and what do you see heading into 2021?

We think the Covid-led selloff that EM experienced is setting the scene for a recovery in 2021. The weaker currencies make the economies more competitive, and the capital flight we saw earlier this year has set the stage for a new cycle.

We also feel that EM dealt with Covid extremely well compared to much of the developed world. In some of the North Asian countries that moved swiftly and aggressively to contain the outbreak, we’re already seeing output exceed pre-Covid levels. Even some of the countries elsewhere that didn’t impose strict lockdowns and, instead, accepted that the virus would spread, are now experiencing growth in output toward pre-Covid levels. So we think EM is set up really well for a strong cyclical recovery in 2021, and that may surprise some equity market participants.

What about EM debt, what has this experience taught us and how are you positioning for next year?

Two lessons that stand out this year are that EM debt is diverse and resilient. We’ve seen markets react differently because the economies and are very different—for example, some are commodity exporters and some are commodity importers. But overall the asset class has proved resilient, and part of that stems from the fact that emerging markets have had to withstand a series of crises over the years, so they are better prepared for these types of shocks.

Looking ahead, the fact the U.S. has joined the zero-rate club for the foreseeable future is a real game changer. This is going to increase the pressure on U.S. pension funds, insurance companies and other institutions that need income. Given the lack of income available elsewhere, we believe the question is not whether to invest in EM debt, it’s how to invest in EM debt.

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We believe the question is not whether to invest in EM debt, it’s how to invest in EM debt.

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Sergio Trigo Paz Head of Emerging Markets Fixed Income

We talked earlier about the outlook for a weaker U.S. dollar, and we think that points to a particularly favorable environment for local-currency-denominated debt, both sovereign and corporate. We see these as good diversifiers from the dollar, but, of course, selectivity will be key.

With selectivity in mind, how are you assessing different regions, countries and industries?

Given the differences in the public health and economic policy responses we’ve seen across EM, we think country selection will continue to be very important. At the sector level, the story is largely about the dichotomy between companies operating in the virtual world and those operating in the physical world. But this bifurcation between physical and virtual is also driving performance at the country level.

When you put all of this together, that leads to a pretty constructive view of Asia, which has benefitted from strong policy responses and provides investors with a great deal of exposure to the technology sector. And with Asia accounting for close to 80% of the MSCI Emerging Markets Index, being positive on Asia translates into a positive view on emerging markets broadly.

Where do you see winners and losers at the country level?

We think the fiscal positions of emerging markets, in general, are in much better shape than developed markets. Unlike in developed markets, there weren’t a lot of handouts to the EM populace. And while deficits have deteriorated, that's largely because revenue lines disappointed. So it’s reasonable to expect that the dollar should weaken against emerging market currencies, at least in real terms.

The countries that typically gain the most in this environment are the ones that borrow the most, because the value of their debt drops in local currency terms. The servicing cost of that debt drops, and that acts like a stimulus to the economy. That group of countries includes Indonesia, Mexico, Brazil, South Africa, Turkey, and—perhaps to a lesser extent—India. We see tailwinds for all these countries heading into next year, and that’s already starting to come through in the earnings of the underlying companies.

Some of the countries that are more challenged are those that have dollar pegs or are otherwise more linked to the dollar. For example, parts of the Middle East that don't benefit to the same extent from capital flows.

Many clients are bullish on China. How do you think the U.S.-China relationship will play out and what does this mean for investors?

Despite the change in the U.S. administration, the relationship will remain a competitive one. There's going to be competition on trade, technology, national security, overall economic stance, and, importantly, on ideology. We really cannot underestimate the importance of the competitive nature of the relationship.

That said, we expect to see more clarity and consistency on U.S. policy regarding China, and we also expect to see greater coordination between the U.S. and other countries in dealing with China. For investors, that means that geopolitics, while still important, won’t be the dominant driver that they’ve been over the past four years. Instead, we’ll see a more diverse set of return drivers—including economic fundamentals and company-specific differentiators—and, frankly, we think investors will view that as a welcome change.

Should investors access Chinese equities via a standalone exposure or as part of a broader EM allocation?

There are good arguments for both approaches. China's very cyclical, and, unlike other emerging markets, it has very short, sharp cycles. That’s because the policy transmission mechanism in China is so quick and so effective. So there is a real opportunity for broad emerging market funds to add value by tactically allocating in and out of China, if they can get these cycles right.

A structural argument in favor of the China-specific approach is the sheer diversity of the stock market there. The liquidity and diversity—particularly in the A-share market—is tremendous. There are roughly 2,000 liquid stocks to invest in, with a huge variety of sectors that you don't really see in other emerging markets. That gives active managers many different levers to drive returns. But one thing to be cautious of with China-only strategies is style bias—it’s something that we see a lot of in that space.

What about the Chinese bond market, how are you thinking about investing there?

The market is seeing increased inflows due to higher rates and investors’ search for diversifying assets. At the same time, the government has successfully managed the pandemic, so rates may not go lower and inflation could rear its head. That type of environment is more conducive to carry trades than it is to duration trades.

Another interesting dynamic we’re seeing is that Chinese bonds aren’t necessarily competing with other EM debt to attract investor inflows. In fact, they’re often competing with investors’ allocations to core developed markets. That’s a reflection of both the zero-rate environment in the developed world and of how much the Chinese debt markets have grown and developed.

To hear more of our investors’ views on emerging markets—including their highest-conviction ideas in both equity and debt—watch the replay of the webcast.

Watch the webcast

Mark McCombe
Chief Client Officer
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Mike Pyle
Global Chief Investment Strategist, BlackRock Investment Institute
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Jeff Shen, PhD
Co-CIO and Co-Head of Systematic Active Equity
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Gordon Fraser
Co-Head of Global Emerging Markets Equities
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Sergio Trigo Paz
Head of Emerging Markets Fixed Income
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