Emerging Markets: Some Light to Carry Investors Through
Author: Regina Chi
April 2, 2020
Investors can be forgiven for being laser-focused on markets close to home as COVID-19 and the fallout from it wreaks havoc on local economies around the world. Nor can they be blamed for paying closer attention to U.S. benchmarks like the S&P 500 and Dow Jones Industrial Average that are often viewed as proxies for all stocks globally.
Yet emerging markets (EM) also have a relevant story to tell, for a number of reasons. Most importantly, the experience of several EMs, in particular China, suggests an arc for the pandemic and its economic impact – one with a beginning, a middle and, hopefully, an end.
EM stocks were among the hardest hit in the early days of the outbreak, which had its epicentre in China’s Hubei province. Through January, as it became clear authorities were struggling to contain the coronavirus, Chinese stocks crashed and other emerging markets followed; overall EM performance trailed developed markets by four percentage points for the month. In February, however, EM stocks staged a sharp recovery, as the number of new cases in China appeared to peak. Yet that rally was short-lived. Two black swan events in March – the oil price war sparked by the disintegration of OPEC+, and the global shutdown to contain the rapid spread of COVID-19 in the West, stoking fears of global recession – brought the recovery to a crashing halt.
Given the scope of the pandemic, it’s not surprising that the correlation of global markets has been very strong; the MSCI World, U.S. and EM indexes are all down in the double digits year-to-date. Yet there has been one significant outlier: China, where the crisis started. In fact, the MSCI China Index has strongly outperformed the S&P 500, declining by less than 4%, measured in Canadian dollars, on the year, according to Bloomberg data.
Clearly, the arc of the coronavirus outbreak in China – from early cases to full-blown crisis and perhaps now to recovery – is at a more advanced stage than elsewhere. Beijing’s efforts to contain the virus were draconian, but effective: about the vast majority of cases in China have been in Hubei, and the number of new cases peaked in mid-February, according to government statistics. As well, the government paired its containment efforts with economic stimulus – lower interest rates, deferred principal and interest loan payments until June and exemptions and/or reductions to VAT and social security premiums, among other important measures.
How long it takes other countries to “catch up” to China might depend on how closely they follow its example. Some, such as South Korea, Singapore and Taiwan, responded early; others have more lately come to the game. Brazil has announced a stimulus package amounting to roughly 4.8% of GDP, according to a UBS report, while packages as a percentage of GDP in other EM countries such as Poland are estimated to be even greater. Depending on the severity of the global recession, top-ups to these expansionary measures are likely. Brazil’s government recently presented a proposal to allow the country’s central bank broad powers to buy public and private sector credits during periods of public emergency. If passed, Brazil’s central bank will be one of the few in emerging markets with a mandate and authority to do quantitative easing.
Given that mixed response, economic recovery in some jurisdictions will probably lag more aggressive ones. Other factors also affect the EM picture. The spike in the U.S. dollar creates headwinds for local currencies, particularly in those countries with high dollar-denominated debt. The oil price collapse hurts producers like Brazil and Mexico, but helps net importers such as India and China. For some, these two factors acting together add further complexity. India benefits from lower oil prices, but the rupee fell to all-time lows against the greenback in late March – and oil is priced in U.S. dollars. Russia, meanwhile, will take a hit from plummeting oil prices, but it has a strong current account that will mitigate the impact of the soaring U.S. currency.
For now, the market on which we have the clearest view is China. The lockdown in Hubei is scheduled to be lifted in April; capacity utilization rates are improving; subway traffic is up; coal and other resource consumption is rising; and some 80% of migrant workers are returning to their jobs, according to UBS. Of course, COVID-19’s economic toll has been severe: China’s Q1 GDP could fall by as much as 40% quarter-over-quarter on an annualized basis, says J.P. Morgan research, and full-year GDP growth could decline from 6% to below 3% or 4% in the absence of further stimulus. However, we expect a new round of demand-boosting spending from Beijing, and the Chinese economy could recover into the second half of the year – perhaps quite rapidly.
China’s experience, along with that of a handful of other Asian EMs, may point the way to the end of the coronavirus pandemic and its heavy economic costs. And while a potential resurgence of the virus could delay an eventual recovery for global markets and remains a concern, there is reason for cautious optimism depending in large part on how quickly and effectively policymakers respond.
In short, this too shall pass – at least in so far as China provides a blueprint. How soon it does, however, is up to us.
Regina Chi is a Vice-President and Portfolio Manager at AGF Investments Inc. She is a regular contributor to AGF Perspectives.
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