Emerging markets set to benefit from shift from west to east

Trade tariffs imposed by US president Donald Trump have created impetus for the big shift in economic activity from west to east that has been underway for a number of years.

The result is likely to make the decade ahead a good one for investors with exposure to emerging markets, speakers at the recent Morningstar Investment conference in Cape Town and Johannesburg heard recently.

The Morningstar research team expects emerging markets, which returned just 3.9 percent a year for the past decade, to enjoy a resurgence on the back of global tail winds, good valuations and good growth potential and to return 10.9 percent in the decade ahead, Roné Swanepoel, head of sales for Morningstar Investment Management, told the conference.

Rise of a new empire

Another speaker, Guy Lundy, leadership consultant and country manager at global executive search and leadership consulting Spencer Stuart, said the shift in global power from west to east coincides with the rise of a new empire led by China.

China’s One Belt One Road program is aimed at investing in infrastructure such as roadways, railways, ports, power grids, oil and gas pipelines in a number of countries in Asia, Europe and Africa to boost trade both by land and sea.

Campbell Parry, a global resources analyst at Investec Investment Management, told the conference Investec is unashamedly bullish on China and the One Belt One Road programme is really quite transformational and scalable.

East Africa is a beneficiary of the Chinese programme and Indian investment with economic growth of around four to five percent and big population growth delivering a growing consumer base, Stuart said.

More evidence of the rise of the economic power of the east is the growth of the BRICS (Brazil, Russia, India, China and South Africa) organisation that aims to improve economic co-operation between these countries.

Lundy says about 20 years ago African trade with the BRICS countries was around one percent. Today it’s around 20 percent and it's expected over the next 20 years to go to around 50 percent, he said.

Brics has also recently increased from the original five countries to include Egypt, Ethiopia, Indonesia, Iran and the United Arab Emirates (UAE).

Many others are lining up to join including Saudi Arabia, he said. When Saudi Arabia joins BRICS, the organisation will make up 48 percent of the global population, 27 percent of global domestic product, 45 percent of agricultural production, 42 percent of global oil production and 25 percent of global manufacture, Lundy said.

US policy boosts China

Trump’s tariff and immigration policies have negative consequences for many countries, but for China, these policies have delivered what China could not have achieved in decades, Liang Du, CEO of Prescient Private Fund Management, told the conference.

Du said the tariffs had made the US an unreliable trading partner and caused many countries to turn to China, as the world’s second largest economy. Countries, such as India and South Korea, were improving trade relations after many years of neglect. 

Another impact of Trump’s immigration policies was the return from the US to China of a number of highly qualified maths, science and engineering students and graduates, Du said.

About 80 percent of maths and science PhD students in America are Chinese or Indian.

Historically the best Chinese people would go overseas, especially to the US, to study and would typically stay, create communities and grow innovation in the US. Now the witch hunt in US academia is causing these students to return home and drive innovation in mega tech companies in China, Du said.

Problems for investors

Some investors and fund managers say China is uninvestable owing to many issues ranging from geopolitical tensions and problems in the property market, tech sector and education sector.

Parry agreed that some parts of China’s economy are problematic and there are risks in accounting and disclosure that investors need to watch constantly.

However, he said there are also many great new ideas, a country that will consume between 40 and 75 percent of commodities for the foreseeable future and consumers are sitting on $1.6 trillion of household savings.

China’s cities are happier, healthier, wealthier, there's much less pollution, and many of their industries are globally dominant, he said.

Parry said China has 250 million university graduates and adds another 10 million every single year, including 30 percent of the world’s engineering graduates and many scientists who will lead the way to the future.

Where catch emerging market resurgence

The conference also considered where to invest to benefit from the expected emerging market boom.

Sonja Saunderson, chief investment officer at EPPF (previously Eskom Pension and Provident Fund) said South Africans should not consider investments at home to be sufficient exposure to emerging markets.

In South Africa there is a lot of exposure to commodities, to dividend paying shares and the lumpy value style of investing, she said.

Emerging countries are more driven by growth exposure, a lot more digital exposure and are therefore affected by different economic factors and will perform at different periods in the economic cycle, she said. 

By complementing your exposure to South Africa with exposure to other emerging markets you get better diversification and a more robust outcome, she said.

Saunderson says the EPPF has exposure to frontier markets that includes Africa and the likes of Vietnam, exposure to China as a separate allocation because it’s size in the index is not well represented, as well as exposure to other countries in the emerging market index.

India getting expensive

India is the second most favourite emerging market and has been delivering strong returns over the past three years, the conference heard.

Peter Koornhof, portfolio manager at Allan Gray, said India, with a population of over a billion people in a very informal economy, has benefitted from the Narendra Modi -led government reforms that have opened up markets and access to foreign capital.

These reforms include simplifying the tax code, a national digital identity scheme that together with a system for real-time payments has enabled many people to enter the formal economy and get access to credit.

Koornhof said India remains a good place from which to manufacture or to deliver services because the country has high productivity, lower labour costs and provides an alternative to China for large companies that do not want all their manufacturing centred in China given the tension between China and the US.

Koornhof said the strong returns from the Indian stock market as measured by its flagship index, the SenSex, have resulted in valuations of shares rising to as high as those for the S&P500 index in the US, and double the average valuation for shares in the emerging markets index.

Allan Gray is therefore seeing more value in other emerging markets such as Vietnam, emerging Europe, South Korea and Taiwan where there is similar growth at half the price-to-earnings multiple of the Indian market and this is a more attractive risk-reward proposition, he said.