By David Ruff, Portfolio Manager

Dozens of central bank tightening moves across EM countries designed to curb inflationary pressures and stabilize currencies combined with lower anticipated US monetary accommodation created a difficult environment for most EM businesses. Additionally, much of the world’s economy depends on the China economic growth engine, and with this machine sputtering as of late, the asset class faces another strong headwind. Accordingly, the MSCI EM Index limped to a 1.50% year-to-date return through November 15th, significantly trailing the double-digit gains posted by developed markets. While we think it may be early to make a resurgence call for emerging market equities, in general, there are elements being put in place which suggest an improved 2022 performance for the asset class. ASEAN, the region covering Southeast Asia, in particular, looks better positioned compared to most developed and developing markets.

For certain, COVID-19 caused a broad-based economic collapse in most EM economies last year and their equity markets suffered a larger drawdown compared to developed peers. Unfortunately, the negative impacts from the disease lingered to a much greater degree in the EM world. Most lacked access to vaccines or the medical infrastructure to immunize quickly, resulting in continued rolling lockdowns, preventing economic recovery comparable to higher-income countries. Supply chain disruptions and worker shortages hit low-income countries especially hard. Although many enjoyed a robust recovery early in 2021, this proved to be brief, with most emerging market regions abruptly losing momentum. Moreover, while multiple developed markets are near or have already exceeded pre-pandemic GDP, almost all emerging markets will require much longer to get back to 2019 output levels. Even ASEAN, which appeared to handle the pandemic relatively well in 2020, struggled in 2021. The IMF, in early 2021, projected the region’s economy to bounce back and grow 4.3% in 2021, but as pandemic-engendered difficulties proved recalcitrant, the IMF slashed projections to under 3%.

As most investors realize, EM underperformance is nothing new. The asset class suffered regularly over the last ten years, deservedly so, with anemic earnings growth, frequent enactment of populist business-unfriendly government policies, all-too-regular social stability-sapping elections, and a lack of information technology leaders. Understandably, professional and retail investors alike exited emerging market equities in droves. Many put the asset class permanently into the dustbin, removing it from their asset allocation models. Understandable, since underweighting these equities for more than a decade has helped returns. Interestingly, however, select EM markets have outperformed since the middle of July, despite their struggling economies. Of course, oil and gas exporting countries like Russia and Saudi Arabia jumped with the 20% price hike in Brent Crude from July 15th and the price doubling in European natural gas, but ASEAN, a region not known for oil and gas exports (except for Malaysia) also recorded leading gains. The FTSE indices from the July 21st low show ASEAN up 10.26% through November 15th. For reference, the S&P 500 is up 7.91% over the same period. Country analysis shows broad-based gains across Southeast Asia. The belle of this ASEAN ball was Indonesia (+16.93%) followed by Vietnam (+13.99%), the Philippines (+13.67%), and Thailand (+10.64%). (All returns are in US dollars).

What makes this especially unique is the state of China’s economy and market during this time of SE Asia equity strength. Historically, China’s relationship to ASEAN can be thought of as akin to the US relationship to Mexico. In other words, when China sneezes economically, ASEAN catches a cold. Lately, however, China is the one needing cold medicine. Third quarter GDP basically stalled in Q3, up just 0.2% sequentially over the second quarter. Covid flareups and flooding hit Chinese urban household consumption and spending shrank 2.5% from Q2. These disruptions also put a damper on the all-important services sector, accounting for 57% of GDP, which managed just 1.9% sequential growth. Coal shortages resulting in electricity generation cutbacks hurt the industrial part of China’s economy. This sector accounts for 39% of GDP and declined 3.3% from Q2 levels. And also recall that China is going through bouts of regulatory intrigue with tougher, less business-friendly policies directed toward a revolving door of industries including technology, e-commerce, social media, fintech, gaming, ride-hailing, crypto miners, student tutoring, and leveraged real estate developers. Chinese equities over this same July 21st through November 15th time period fell 8.25%. Normally, China problems signal trouble for the ASEAN economies and equities through the trade mechanism.

Several SE Asia countries, despite all these China headwinds, now look to be on a more sustainable recovery track. Indonesia, Vietnam, and Thailand, for instance, all registered notable manufacturing strength in the third quarter. This certainly helped, but more importantly for their equities’ near-term performance, the countries have adopted a live-with-COVID attitude. In other words, despite facing exponential case increases, these countries believe relief from the pandemic’s limitations is necessary for economic restoration. Not only will this benefit lockdown-exhausted populations as authorities relax restrictions and reopen shopping malls, restaurants, and shops, it will also help to restore disrupted global supply lines. Before this policy shift, Malaysia, a key chip testing and packaging provider to the electronics industry cost Apple iPhone production when lockdowns were imposed, and Vietnam’s factory closures negatively impacted numerous multinational companies such as Samsung and Toyota.

As these examples illustrate, SE Asia has already become a key cog in several global supply chains, and we believe the region’s importance to the global economy will expand. Increasingly, US, EU, and Japanese companies want to move some of their eggs away from the China basket, and ASEAN provides the best option. Implementing a region-wide, free-trade agreement and taking steps to harmonize regulation reduces transaction frictions and provides a more unified, integrated, cohesive business environment. Combine this with an attractive demographic—that is, a lower cost, progressively mobile workforce with improving skills—and you have the necessary ingredients for corporations to thrive. Companies are taking notice and allocating investment accordingly. The following graph reflects climbing FDI (foreign direct investment) by countries outside of ASEAN. This should accelerate going forward.

Other factors also suggest Southeast Asia represents an attractive destination for business. Learning that foreign-sourced, US-dollar denominated debt has a downside during times of crisis, ASEAN denominates most debt in local currency now, and sports much lower debt-to-GDP ratios compared to developed markets. They have also been successful in growing their trade surplus. This suggests a taper-tantrum should be less impactful to the region compared to the past with less volatile currencies and equities. The following chart from ASEAN.org exhibits the much-improved trade balance for the region.

Emerging markets comprise 37% of global GDP on a nominal basis, according to The World Bank, and 60% on a purchasing power parity basis, according to the IMF, yet they’re only 12% of the globe’s equity market capitalization. This is frequently quoted to support the idea of EM investment, but this point is not compelling to us. GDP generation does not guarantee successful equity investment opportunities. Indeed, much of China’s GDP “growth miracle” since 1992 came from non-listed small businesses and primarily stated-owned enterprises with limited access for US investors. We also don’t advocate general EM investment. We think winners and losers in EM will be more pronounced coming out of Covid, and ASEAN will be better than other regions. Finally, we believe our ability to identify profitable, cash-generative ASEAN or ASEAN-exposed companies with better corporate governance will provide a more attractive return for investors. In other words, don’t let the last ten years’ returns result in a home bias that totally dominates your investment portfolio. Save a part for the coming ASEAN growth story.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

About the Author

David Ruff

David Ruff

Prior to joining ACM as a Portfolio Manager, David Ruff was a managing director and senior portfolio manager at Salient where he co-managed the Dividend Signal Strategy® portfolios. Previously, David was chief investment officer for Berkeley Capital Management. In 2008,...
About the Author

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