“Going viral” has taken on several new meanings over the years. In a world where we are confronted with an actual
virus and businesses that thrive from the phenomenon of going viral over digital platforms, we have faced both serious
societal challenges and investment opportunity all at once. Have both phenomena run their course? While we lack a
crystal ball, in our opinion, the future is bright. In many ways, this is particularly true for emerging markets.
Now and then
From 30,000 ft. to important long-term characteristics,
current fundamentals and common objections, we believe
emerging markets is an area investors should see as a
capital appreciation solution now and for the future.
Valuation: In the current environment, where earnings
have been severely depressed and volatile, we believe a
fair valuation metric to review for relative comparisons is
the Cyclically Adjusted P/E ratio (CAPE), also known as
the long-term P/E ratio.
CYCLICALLY ADJUSTED P/E RATIO (CAPE)
Generally, global equities are currently above their
long-term average CAPE ratio. But non-U.S. equities are
relatively less expensive in both an absolute and historical
context. While valuation is important, on a stand alone
basis, it isn’t necessarily predictive, which brings us
Growth: With COVID-19, the scarcity of growth has
generally led to a greater premium in areas where it is
strongest and most sustainable. Much like we have seen
on an individual stock basis in recent years where growth
has commanded a significant premium, regions of the
world have experienced the same through the pandemic.
A growth advantage may continue to favor emerging
GDP AND EPS GROWTH
Source: GDP Growth: International Monetary Fund, 2/28/2021 Earnings Growth (MSCI indices):
Thomson Reuters I/B/E/S. Past performance is no guarantee of future results.
On the world stage, emerging market equities have a
long runway. They still represent a mere 13.7% of global
equity market cap, yet have far greater significance to
world output and future growth.
Valuation and growth can be powerful predictive
characteristics. This, along with greater prevalence
within the global economy, bodes well for emerging
markets. It is a good recipe for long-term capital
appreciation. However, the world is rapidly changing.
Investing in businesses on the right side of that change
is important. So naturally one should ask: When
investing in emerging markets, what am I investing in?
Like the U.S., in emerging markets innovative
technologies, consumer platforms, and business models
have been the focal point for investors. Those
companies that can create and implement innovation
have generated superior economic value. With
COVID-19, many of these innovative trends have
accelerated and will likely succeed in a sustainable
manner for many years.
Innovation: Creation and adoption
In the developing world, technology and innovation
leaders have emerged, an ambitious population and
increased social mobility drives entrepreneurship, and a
large consumer base has adopted technology quicker
than developed world consumers.
Innovation vs. Market Capitalization — Unicorns, a term that
refers to private companies with market values greater than
$1 billion, are considered the “nursery” for future innovation
leaders and soon-to-be public companies (IPOs). This bodes
well for the future growth and expanding investment universe
in emerging markets.
If the future of corporate growth is largely grounded in the
creation and adoption of technology, then we believe
emerging markets is a prime area of the world to invest in
such growth. It is home to many of the world’s most
innovative up-and-coming companies.
As a long-term investor, it is important to understand
the characteristics that can drive trends sustainably into
the future. For example, if the U.S. implements more
stringent IP protection against China, will that lead to a
decline in their ability to innovate? Several statistics
point to the ongoing ability for China to create and
continue their path of entrepreneurial success across
Patent Applications by Country (2018)
Source: WIPO — World Intellectual Property Indicators 2019.
Countries with the most STEM graduates (2016)
Source: World Economic Forum.
China accounts for nearly half the patent applications
in the world. It is also home to the most graduates from
science, technology, engineering and mathematics
(STEM) programs. This will enable them to continue to
develop globally competitive technology and medicine.
Areas where we are likely to see them thrive for many
Growing wealth of the middle class, millennials and
adoption of technology: Emerging markets is home
to the largest consumer base in the world. One that
continues to grow in size and wealth. It is also a
population that has adopted technology. Companies
with a competitive edge, particularly those with the
ability to reach their consumers through smartphones,
seem to be well positioned.
Smartphone trends favorable in emerging markets
Source: World Economic Forum.
The virus may have long-term fiscal effects
How will it impact emerging markets? When the world came to a screeching halt in March
2020, governments and central banks stepped in to
support major economies. Essentially, bridging the
economy from one side of the abyss to the other.
Countries in each area of the world took different
approaches toward handling of the virus and, as a result,
their approach to government support as well. These
decisions could have lasting effects.
To distance or lockdown?
In select Asian countries, extreme lockdown measures at
the early stages of the virus resulted in containing the
spread. This allowed these economies to get back to a
more “normalized” state when compared to societies
that encouraged behavior and set certain restrictions,
but was moderate in enforcement.
14 Day COVID-19 cases - per 100k
Source: European Center of Disease Control; as of 12/31/20
Many of the long-term effects from the pandemic will
emerge over the coming years, but certain symptoms
are already evident. Excessive spending in developed
countries is manageable, but may prove to be a
Emerging Markets: Objections to investing in the region
Emerging markets is a cyclical, commodity driven
market that benefited from China’s growth and
infrastructure boom, but China’s growth is slowing: China is decelerating, but it is still the second largest
economy in the world. Growth of just 4% creates a
meaningful amount of economic activity, adding roughly
the equivalent of Sweden’s annual GDP. Also, emerging
markets has a different investment case than it did 20
years ago, with the innovation boom and also supported
by the evolving investment landscape.
The evolving investment landscape — 2000 to 2020
Source: World Bank, Bloomberg, FactSet 12/31/2019.
Emerging markets debt: Debt in emerging markets
remains a risk as they continue to borrow, particularly
if the global economy takes longer than expected to
recover. However, for the most part, debt burdened
countries do not consist of a large part of the equity
universe. Countries that have had the greatest issues in
recent years, like Turkey and Argentina, are relatively
insignificant in the equity world. Also, the world used
to be less integrated and, thus, less concerned about
emerging-market crises. Whereas now, rescue packages
and organized debt restructurings are more prevalent
and likely. Contagion is less of a risk.
China’s equity rally has been driven by an unsustainable
retail surge: Yes, China has experienced inflows from
retail investors, much like the Robinhood phenomenon
the U.S. has seen during the pandemic. For China, many
are comparing it to 2014 when a retail boom cycle led to a
bust in the market. While this is always a risk, there are
differences this time that may mitigate the risk. There are
more foreign institutional investors, more local
institutional investors (active mutual fund issuances are 4
times what they were a year ago), and the government is
more aware of the risk. As such, we believe there are more
active participants to temper the risk.
Emerging markets has been a bad place to invest
compared to the U.S.: On a relative basis, emerging
markets has not performed well over the last decade
and investors have been waiting for the tide to turn.
Historically, regional leadership has worked in cycles.
In the early part of the century, emerging markets
prevailed, though, since the financial crisis, the U.S.
has outperformed emerging markets. Despite this
relative underperformance over the last 10 years,
emerging markets has still created value for investors.
While volatility is generally higher, investors have seen
return for that additional risk.
The opinions expressed in this article are those of Ivy Investment Management Company and are not meant to predict or project the future performance of any investment product. The opinions are subject
to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a
recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs,
risk tolerance and time horizon.
Risk factors: Investment return and principal value will fluctuate and it is possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or economic
conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investments in countries with emerging economies or
securities markets may carry greater risk than investments in more developed countries. Political and economic structures in many such countries may be undergoing significant evolution and rapid development, and
such countries may lack the social, political and economic stability characteristic of more developed countries.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways
that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the
COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.