Emerging markets regions building resiliency amid geopolitical shifts, tariff woes

A resilient, resourceful China

China had a first-hand view of the impact of tariffs during President Trump’s inaugural term and has already taken steps to safeguard its economy through stimulus and building out its trade partners.

The last few years have seen some talk about emerging markets ex-China strategies, but this path is proving challenging to bring to fruition as China has the second largest economy in the world. “It’s one of the largest equity markets in the world and — given its rapid development, particularly recently — in more advanced technological spaces, it will always be an important part of the global market environment,” says Nick Chamie, senior managing director, head of total portfolio and capital markets and chief strategist at the Investment Management Corp. of Ontario.

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The main engine of growth for China remains domestic consumption and government spending, says Laurence Bensafi, portfolio manager and deputy head of emerging markets equities at RBC Global Asset Management in the U.K.

When it comes to emerging markets growth projections this year, she says investors are keenly watching how China and other governments will try to fix critical issues, such as flailing property markets and stimulating consumption. She suggests the recovery period for China will be gradual and, although the government has tried to incentivize the property market by dropping some constraints, she notes more needs to be done to stimulate consumption recovery.

Still, Bensafi says China’s economy continues to show signs of resiliency, growing between four and five per cent. Exports are helping, she adds, noting while exports from major trading partners like the U.S. have decreased over the past few years, exports have increased with other countries and regions, including India, Latin America and the Middle East.

“They’re doing extremely well because, obviously, China exports its deflation. So as long as it can generate this four or five per cent growth and the population . . . doesn’t seem too unhappy or . . . you don’t see social unrest, [the] very gradual stimulus [should continue].”

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Notably, the uncertainty is priced into China’s equities market, says Bensafi, which makes it relatively inexpensive with low valuations. “We still believe China and the U.S. are too important for each other and that negotiations will lead to a better outcome than the very high tariffs announced at the beginning of April.”

In the meantime, Mexico, which has a relatively inexpensive equities market, has overtaken China as the U.S.’s largest trading partner. As of mid-April, Mexico had escaped tariffs from the U.S., but the situation remained very fluid.

China is in a very different position, notes Bensafi, because the impact of tariffs on its gross domestic product growth is estimated to be much lower (roughly one to two per cent), which wouldn’t stimulate a recession if it’s poised to see four to five per cent growth.

As well, China has a few more options on the table compared to other emerging markets countries, she says, noting it can speed up a consumption stimulus and build more factories in the U.S. or import more U.S. products, such as grain, which are steps it has taken in the past.

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In contrast, Southeast Asia has been extremely volatile, in part because the economies of many countries in the region could be adversely impacted by the tariffs. Vietnam, for instance, has the biggest exposure, says Bensafi. In early April, the U.S. imposed a 46 per cent tariff on Vietnamese imports. According to a report by Reuters, exports to the U.S. accounted for 30 per cent of Vietnam’s GDP last year.

“In terms of GDP from exports to the U.S., if the U.S. decided to keep the tariffs announced on the country, there isn’t much it could do to offset the effects,” says Bensafi.

Expanding trading partners

China isn’t the only nation seeking out new trading partners — a more hawkish U.S. on the geopolitical trade front is forcing countries to invest in new regions.

The result of this global realignment is more factories being built in places like Africa and South America. “Deglobalization, in its various forms, is going to be the overriding driver for economies and markets in the foreseeable future,” says Chamie.

Deglobalization isn’t just about the free flow of trade, he notes, it’s about geo political world order and stability — the free flow of people and capital. “We came from a world where, . . . pre-2016, a drive towards globalization in all its various forms . . . was seen as a force of good in the world — income distribution, growing the size of the pie and also a better distribution of the pie, globally. But, as with all pendulum swings, it gets to one end and invariably swings the other way. And so, we’re on the second half of that pendulum swing now and it seems to be picking up speed.”

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For the most part, Latin America has done relatively well, with Mexico the recipient of the highest foreign domestic in vestment, says Bensafi. Meanwhile, Brazil has a somewhat mixed outlook, she says, noting that, if bond yields were to decline, it could become a very interesting high beta market where both the currency and stock market could recover sharply.

Changing fundamentals

While many emerging markets have seen improving innovation, infrastructure and changing demographics, these fundamentals aren’t yet reflected in their valuations, says Bensafi.

For example, the Middle East, including Saudi Arabia and the United Arab Emirates, is booming. “They’re building a lot of infrastructure, . . . renewable [energy companies], . . . tourism and they’re importing a lot from China. So that’s a really good way of diversifying [their economies].”

Saudi Arabia, which has long been a dominant force in the Middle East due to its larger population, has launched ambitious investment projects over the last few years, says Kamil Dimmich, portfolio manager and partner at North of South Capital, but its flashy market has meant some of its stocks, which tend to be more expensive, have been derated. The country is focusing on diversifying its markets so it’s less concentrated on oil production, while its changing demographics include a growing population that’s young and educated, he adds. As a result, many investors have increased their exposure to its equities market.

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The UAE is also showing positive demo graphic growth due to very pro-immigration policies, says Dimmich, noting it’s aiming to grow the population of Dubai from 3.5 million to 5.8 million by 2040. “Pretty much any industry [in Dubai] is a growth industry and the market is very inexpensive.”

Much of the money pouring into Dubai is from India’s wealthy and middle class, either visiting on holiday or buying properties, he continues, adding the city is benefiting from the growth seen in India without the very high valuations that Indian stocks now command. “The Indian economy has been growing rapidly, but is now slowing, which means its highly valued equities market is vulnerable.”

Many institutional investors are favouring Taiwan due to its technology companies holding unique positions globally in the tech and artificial intelligence supply chain. “We know Taiwan Semiconductor Manufacturing Co. Ltd., which is the largest by far, but then there’s a whole series of other companies that are less high profile, that also have very interesting dominant positions in their segments [and] that are benefiting from these tailwinds,” says Dimmich.

However, while these stocks have traditionally been inexpensive, he notes many have increased in price due to the excitement around AI. “TSMC has performed extremely well — [its] stock almost doubled last year — but [it] remains attractively valued relative to the growth prospects and relative to the very low cost of capital in Taiwan.”

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Bensafi agrees, noting TSMC has been a key investment in RBC GAM’s portfolios. “[The company] produces something that everyone wants and no one else can make. . . . You can put it with the top . . . companies in the world, such as Apple and Microsoft. Our view was always that it was undervalued as a company [and] too small. . . . It’s been doing incredibly well and now everyone knows about it.”

However, she cautions the buzz has led to other countries investing in building their own semiconductor plants, particularly the U.S. and Germany. Notably, TSMC recently announced plans to mass produce chips in Arizona and, according to a report by Reuters , the company has agreed to open up five new plants in the U.S.

Down the road, this could affect TSMC’s margins since it’s a costly endeavour that could take years to come to fruition, says Bensafi. However, she expects the majority of production will remain in Taiwan for a long time.

Expert boots on the ground

While the emerging markets hold growth opportunities, the political landscape in many regimes holds some risks.

The potential effect on companies calls for a diversified approach that includes tap ping into regional specialists who can pick up the best ideas, says Denise Kehler, head of delegated portfolio management in Canada at WTW Investment Management Canada Ltd.

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“We favour having a really diversified approach to emerging markets that has skilled managers that can be [more] nimble than individual investors and really consider real-time assessment of where to find those best opportunities. We’re accessing those markets through global emerging markets managers that we think are quite skilled at shifting between those country opportunities.”

This approach has helped the organization find good opportunities in regions such as Africa. “We’re definitely looking for managers that have boots on the ground . . . [and a] history of being able to assess the risks and the opportunities,” says Kehler. “And we’re looking for managers that are highly dynamic in terms of what they’re doing.”

It’s also important for managers to be aligned with the firm’s policies, including in areas such as environmental, social and governance considerations, she adds. “We want to make sure our managers are engaging . . . [in] ESG considerations when in emerging markets . . . and [are] factoring that into their opportunity set.”

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Before making any investment, institutional investors need to really get to know a company, including its management and the country in which it operates, says Bensafi, noting government regimes and reforms in emerging markets nations are subject to constant change and tend to be quite volatile. If investors stay focused on long-term secular growth areas, she adds, they should do well, regardless of what’s going on in the world.

Lauren Bailey is a former associate editor at Benefits Canada and the Canadian Investment Review.