The coronavirus pandemic has been truly a unique emergency, characterized by the unfortunate theme of winners and losers. The health crisis and economic fallout have disproportionately damaged the weaker constituents of society, the economy, and financial markets. As such, extrapolating this trend to describe the dynamic of the crisis with respect to advanced and developing economies seems obvious. A nuanced look, however, paints a more encouraging picture.

Policy Response: The Kitchen Sink
Emerging market (EM) economies have by no means been immune to the damage of the sweeping economic full stops triggered by draconian lockdown measures in early 2020. It is important to note, however, that these economies entered the crisis from a point of relative strength, which helped their resiliency. The unprecedented level of monetary accommodation provided by emerging and developed economy central banks alike has only further increased the resilience of EM economies. And while EMs clearly have less flexibility for the massive fiscal spending programs seen from developed economies, their exposure to global growth and trade helps to support their growth without as much impact to fiscal health. The net result is a stronger growth outlook (Figure 1) and relatively stronger fiscal health (Figure 2) as compared to advanced economies.

Figure 1: JP Morgan Growth Forecast Revision Index (12/31/19–7/31/20)

chart


Figure 2: IMF Gross Government Debt Projections (2018–2021F)

IMF gross gov debt projections

Manufacturing to Lead the Way
Massive and rapid policy response on both the monetary and fiscal fronts has been a significant driver behind the V-shaped recovery seen in financial markets and the considerable recovery in economic activity. The theme of “winners and losers” shows through nonetheless, as goods consumption has fully recovered while service industries continue to struggle. Virus fears and mitigation policies continue to place a cap on the full return to normalcy that many service sectors rely upon. The result is a rapid recovery in the manufacturing sector while the service sector continues to lag. While developed economies like the US are dominated by service industries, representing nearly 80% of GDP, emerging economies such as China are still heavily reliant on manufacturing and agriculture, driving nearly 47% of GDP. The recovery will likely continue to be led by the manufacturing sector, which should support the recovery under way in emerging market economies.

Weighing the Risks
While there are certainly reasons to be optimistic on the prospects for emerging markets, investment within the region is not without its risks. A byproduct of the massive monetary easing undertaken by emerging market central banks is lower interest rates. Appreciation from currency exposure historically plays an important role in total returns for emerging market equity and debt investments. Lower levels of interest rates make investment in these currencies less attractive, thereby weighing on EM currency performance. And while EM exposure to global growth is supportive of its domestic recovery outlook, it does leave these economies vulnerable to virus and reopening stumbles in other countries. Nevertheless, signs continue to point to a recovery in global growth.

Know What You’re Buying
Investors seeking to capitalize on these dynamics in emerging markets must consider two key factors: country and sector exposure. Remember, the winners and losers dynamic is at play. China now represents over 40% of EM equity indexes, while Taiwan and South Korea account for an additional 12% and 11.5%, respectively. Strong policy support within these countries has helped to kickstart a robust recovery and offer attractive opportunities. In addition, the technology, communication services, and consumer discretionary sectors represent over 50% of the index. These sectors have seen demand for their products skyrocket as “the new normal” has accelerated the reliance on technology and e-commerce that was well under way prior to the crisis. While some countries and sectors within the EM indexes will continue to face headwinds moving forward, China in particular and the technology and communication sectors are likely to continue to weather the pandemic crisis. Should the global recovery continue to gain momentum, emerging markets are likely to continue to benefit and draw investors to a significantly under-owned asset class.

As with any investment opportunity, one must weigh the risks and rewards with one’s own investment goals in mind. A well-developed financial plan is always an important part of the investment process, but for those searching for a way to capitalize on continued tech dominance and benefit from a further recovery in global growth, EM equities stand out as a compelling opportunity.

Foreign and Emerging Market Securities Risk:
Foreign and emerging market securities may be subject to greater political, economic, environmental, credit, currency and information risks. Foreign securities may be subject to higher volatility than US securities, due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets. Equity Securities Risk: Equity securities are volatile and can decline significantly in response to broad market and economic conditions. Currency Risk: Currency exchange rates between the US dollar and foreign currencies may cause the value of the fund's investments to decline. Non-diversified Risk: Non-diversified funds invest a greater portion of assets in fewer securities and therefore may be more vulnerable to adverse changes in the market. Concentration Risk: Concentrated investments in a particular industry may be more vulnerable to adverse changes in that industry or the market as a whole.

Before investing, consider the fund's investment objectives, risks, charges, and expenses. You may obtain a prospectus or a summary prospectus containing this and other information. Read it carefully.

The views and opinions expressed may change based on market and other conditions.

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