A deepening divide: emerging markets and the second-quarter earnings season

Emerging Markets

Emerging markets (EMs) are often discussed as if they were somehow homogenous. That, however, is misleading. The differences between the individual markets included in EM indices are profound. The Covid-19 crisis has exposed these fundamental differences – especially those between emerging Asian economies and other parts of the developing world. And EM companies’ second-quarter earnings are clearly reflecting that divide.

One important distinction is the state of public finances in different emerging regions. Asian countries such as China, South Korea and Taiwan – which together account for 80% of emerging Asian equity market – benefit from having lower government-debt ratios (between 20% and 45%) and relatively modest balance-of-payment deficits.

This contrasts sharply with countries like Brazil (63% of the Latin America equity index) and South Africa (30% of the Europe, Middle East and Africa, or EMEA equity index) where investors are concerned about widening fiscal deficits and ballooning public debt: in 2019, government debt stood at 76% of GDP in Brazil and 62% in South Africa.

Away from the macroeconomic aspect, there’s also a pronounced divide in the corporate environment, reflected in the equity weightings to different industries. Asia provides substantial exposure to information technology (IT) names, which makes up 20% of the EM Asia index. In Latin America and EM Europe, on the other hand, the largest sectors are financials, materials and energy. Meanwhile, IT companies are almost entirely unrepresented, at less than 1% of both indices.

Deepening the divides

The Covid-19 pandemic has deepened both of these divides. All countries must contend with the enormous costs entailed by lockdown; those with more robust public and corporate finances should be able to come through the crisis in better shape.

All countries must contend with the enormous costs entailed by lockdown

The different market structure of those economies has led to different outcomes too. Asian markets have companies that were direct beneficiaries of the imposition of lockdown and social distancing: conditions that benefit technology firms, online platforms and other online businesses. Meanwhile, the rest of the EM world entered the crisis with an outlook for commodities that was already challenging before the virus struck, given the heightened volatility in the energy market stemming from the price war between Russia and Saudi Arabia; neither country has been willing to cut production to support falling oil prices.

Another key point is that, in the past, China has been a key driver of commodity prices and an important source of support for EM economies in times of crisis. But Beijing has reacted to the Covid-19 pandemic with monetary and fiscal stimulus packages that differ considerably in composition from those delivered during the global financial crisis and the 2016 slowdown.

View Full Article – published by Aberdeen Standard Investments on 4th September 2020

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