Private banking

Emerging markets show strong growth potential, but are vulnerable to global ripples

Investors can find good opportunities in emerging markets, but are advised to keep a watchful eye on big-picture developments – such as US interest rate hikes

PUBLISHED : Monday, 22 May, 2017, 2:48pm
UPDATED : Monday, 22 May, 2017, 5:45pm

Always of interest to investors with an eye to better than average returns, Asia’s emerging markets – and others around the world – are sure to be closely scrutinised over coming months.

The potential for growth is beyond doubt, whether propelled by export manufacturing, natural resources, or an expanding consumer base. But near-term uncertainties, often linked to ripples emanating from the United States, mean the prospects for individual countries can still soar or sour with limited advance warning.

“The domestic policy environment looks fairly stable in most of Asia’s emerging economies, so we are mainly focused on two external factors,” says Richard Jerram, chief economist at the Bank of Singapore. “Potentially, the most problematic is US trade policy. And the second is how emerging markets respond to higher US interest rates.”

Regarding the former, Jerram notes that, so far, the Trump administration has not been aggressive in terms of action to back up its sometimes harsh rhetoric. However, that situation could change without warning. And if one result is increased pressure on China, there could easily be adverse knock-on effects for the rest of the region.

Concerning the latter, Asia appears relatively insulated, with many economies running an external surplus and holding sizeable reserves of foreign exchange. Still, though, there will inevitably be uncertainties as the broader economic environment recalibrates after a long period of ultra-low borrowing costs.

“Asia has been one of the main beneficiaries of globalisation in the past few decades,” Jerram says. “So, if talk about “America first’ translates into higher tariffs across the board, that could be very bad news for Asia. At this point, though, it looks more of a slogan than a coherent set of policies.”

Assuming a better-case scenario, Jerram sees good growth prospects in Vietnam and the Philippines. Also, the bank’s equities team recently upgraded its view on Indonesia, giving it a positive rating as a laggard market with a strong domestic dynamic.

That said, private investors tread carefully, recognising that the link between big-picture outlooks and financial market performance can be complex.

Asia has been one of the main beneficiaries of globalisation in the past few decades
Richard Jerram, chief economist, Bank of Singapore

“Never lose sight of the importance of valuations,” Jerram says. “Overall, that’s why we are fairly cautious on equities at the moment, as valuations are generally stretched and there are plenty of policy uncertainties. But we still see merit in looking for yield in fixed-income markets. Solid growth implies limited default risk, and US interest rates are not likely to rise too quickly.”

For Prashant Bhayani, chief investment officer, Asia, for BNP Paribas Wealth Management, the pace of US monetary policy will be a key factor for Asia this year. However, even two rate hikes should prove manageable.

Also, with the fear of large one-off tariffs and US-imposed protectionism now dissipating, and with China no longer labelled a currency manipulator, there are increasing signs that “business as usual” will be the order of the day.

Furthermore, China is putting in place measures to slow the rate of credit growth and reduce the use of leverage in certain sectors. This is important in the context of the overall reform process and points to greater stability, an obvious attraction for investors with a view to the medium term.

“We are overweight in Asia ex-Japan equities, including both India and China,” Bhayani says. “This has paid off year to date, with most market participants not expecting such a strong performance.”

He describes China, in particular, as a value market where the government is taking a pragmatic approach. They can be expected to give continued and targeted support through expansionary fiscal policies if growth shows signs of faltering.

“Therefore, we remain positive on Chinese equities,” Bhayani says. “They have underperformed other Asian markets in the past few years, but valuations today are attractive.”

More specifically, attention is focused on financials for their yield protection and on infrastructure- and environment-related plays because of their tie-in with policy initiatives.

Chinese technology stocks are also in favour for their strong year-to-date earnings and, in some cases, for their increasingly dominant market reach.

Looking to India, there is a similar sense of broad optimism. The economy is recovering from the one-off hit to GDP caused by demonetisation, while moderate oil prices and a thorough-going slate of reforms should give a further boost.