Not long ago, emerging market (EM) equities suffered one of the longest down periods on record. Weighed down by the rising US dollar and uncertainty around the Chinese economy, the Morgan Stanley MSCI EM index fell nearly 40% from its February 2021 high to its October 2022 low. But as dollar strength potentially peaks and China eases COVID restrictions, the outlook for emerging markets improves.
What is an emerging market? The term "emerging markets" was coined by economists in the early 1980s to define investment in developing countries. Today there is no absolute definition, but most experts agree that the term refers to countries with rapid economic growth.
The term generally refers to the economies of countries undergoing industrialization as they develop and whose share of global GDP is growing rapidly. In 2020, the 37 markets covered by the Oxford Business Group (OBG) accounted for around 21.6% of the world's population and approximately 9.6% of global GDP. Some emerging markets, such as South Korea, have many consumers and a prosperous economy, while others, such as areas in Southeast Asia, the Middle East, and Africa, are still in the early stages of developing a strong economy and stable environment.
Is it worth investing in emerging markets?
Emerging markets and developing economies account for about 80% of global economic growth, according to the International Monetary Fund (IMF). They also account for about 85% of global consumption growth, more than twice as much as in the 1990s.
For every emerging market success story like South Korea, there is a struggling Venezuela or Russia. Like anything that experiences accelerated development, emerging market economies can have growing pains, so investors must be aware of the volatility that often comes with this asset class.
There have long been relative winners and losers, so it is important to be discerning in this asset class. Several Latin American countries benefit from favorable trends in monetary policy, inflation, and global trade, which could generate strong momentum for equities in 2023.
In the case of Brazil, the overall consumer price index has fallen sharply from 12.1% in April 2022 to 5.8% in December, with the expectation that the anti-poverty program will support labor market improvements that could help strengthen economic growth. In addition, China's economic reopening will likely drive strong trade expansion for Brazil.
For Mexico, where tourism accounts for 15% of GDP and 13% of all jobs, and where 70% of international travel comes from the U.S., a likely slowdown in tourism from the U.S. is a short-term drag. Similarly, sluggish sales in the automotive sector, which accounts for 20% of Mexico's manufacturing output, may also weigh on growth. However, a trend of "near-shoring," which drives global companies to move supply chains closer to home, could substantially boost U.S. investment in Mexico, which could experience a $155 billion increase in exports to the U.S.-or more than 10% of Mexico's GDP. or more than 10% of Mexican GDP - over five years.
Emerging markets can stretch and offer investors growth and upside momentum in boom times but can pull back when market cycles change. While a high portfolio percentage in emerging markets may not be desired, a modest 5% to 10% allocation could add an additional layer of diversification.
In sum: Latin American stocks are likely to be undervalued in global portfolios relative to their contribution to global equity market capitalization. Inflation in Latin America peaked in June 2022, giving policymakers more room to begin slowing monetary tightening, which is likely to favor the region's equities. Latin American stocks trade cheaply, relative to their history and global peers, and could outperform emerging market stocks in general.
Brazil could benefit from expanding trade with China, and Mexico could experience increased exports to the U.S. as companies move their supply chains closer to home.
By the end of this year, investors will have reassessed their exposure to these opportunities in Latin America, with a particular focus on Brazil and Mexico.
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