The performance gap between East Asia and other emerging markets has never been greater than in the first five months of 2020. At first sight, the cause looks obvious: coronavirus. But in the background there is a different dynamic at play.
Ironically, the ranking of best-performing stock markets in 2020 is led by China, the country where the pandemic originated. Korea and Taiwan are also well on their way, and in any case doing much better than most other emerging markets (see graph below).
The difference in performance seems easy to explain at first sight: in North and East Asia, the coronavirus outbreak has been under control for some time now. There have been few new coronavirus outbreaks in recent months, lockdowns have eased and the economy is recovering. The contrast with countries like Mexico, Russia, Brazil and India is huge: here the epidemic is far from under control, and the number of new infections is still increasing on a daily basis.
To make matters worse, these countries are also largely dependent on the export of raw materials, prices of which have collapsed due to the corona crisis. ‘We have therefore reduced our exposure to Brazil and Indonesia,’ says Devan Kaloo, head of emerging markets at Aberdeen Standard Investments. The allocation to Mexico, which has been hit hard by the US economic crisis and the shutdown of production in many factories, has also been reduced.
But the other side of the coin is that the strong correction this year has led to attractive valuations. ‘That’s why we will continue to consider these countries, also because there are enough attractive consumer-oriented companies to be found,’ says Kaloo.
Winners versus losers
It may be obvious to draw the dividing lines in emerging markets along the different regions, but ultimately the market dynamics there are the same as in developed markets. A small group of (growth) stocks benefits from the crisis, while others are being hit hard. The winners are mainly in East Asia while the losers, mostly cyclical sectors such as banks and commodity stocks, are relatively dominant in the equity markets of many other emerging economies.
‘The Covid pandemic is leading to the same acceleration of trends in emerging markets that we see in developed markets,’ concludes Dennis Eldridge, investment specialist EM equities at JP Morgan Asset Management. ‘Especially the what I call stay-at-home beneficiaries are benefiting from the crisis. These are mainly e-commerce companies, cloud service providers and companies that sell online games, such as Alibaba and Tencent.’
Strong balance sheets
This year’s strong performers also all have in common they are market leaders, have strong balance sheets and relatively few fixed assets. Companies with weak balance sheets and many assets, on the other hand, are having a hard time. An example of this last category is the travel industry. People will travel less over the next few years, while before the corona crisis strong growth was expected in emerging markets. And that change may prove to be permanent.
‘Now that employees have become accustomed to using technology [such as Skype or Zoom] to communicate, they may be less likely to take a plane for a business trip, and this may remain the case once the pandemic is over,’ says Eldridge. ‘That’s why airlines, hotel chains or other businesses that depend on travellers have seen a downturn they’re unlikely to overcome quickly.’
Belarus
Most of the ‘winners’ of the coronavirus crisis may be located in Asia, we also find some of these in Latin America and Russia. After all, online shopping is also taking off there now.
‘The penetration of e-commerce is still relatively low in Latin America, but has now gained momentum thanks to Covid-19,’ says Kaloo. ‘We have therefore increased our allocation to an e-commerce company that is active throughout Latin America, and also added other structural winners to our portfolio. Like an e-commerce platform from Russia.’ Kaloo declined to say which companies are involved, but Mercado Libre is the only international e-commerce platform listed in Latin America. The same goes for its Russian counterpart Yandex.
The JP Morgan EM Equity fund also has a technology company from an unexpected location in its ranks: Epam Systems from Belarus, a country that has been mainly in the spotlights in recent weeks because of President Lukashenko’s recommendation to drink vodka for protection against the coronavirus.
‘Epam designs digital platforms and IT systems. It is originally from Belarus, but is listed on the New York Stock Exchange and has clients all over the world,’ Eldridge says. The company is the fund’s seventh largest position, with a weighting of 2.7%.