After multiple headwinds over the past year, emerging markets have a brighter, albeit challenging, forecast in 2019. Slowed U.S. Fed policy could ease pressures on local central banks, leading to a more supportive theme, but geopolitical issues and the trade war remain major threats to emerging markets growth.
Emerging markets faced multiple headwinds this year, namely
a strong dollar, China’s focus on deleveraging and regulations,
trade wars, volatile energy prices and increased geopolitical risks.
By comparison, U.S. returns benefitted from a more attractive
growth rate, which was the result of tax reform, lower regulatory
pressures and repatriation of overseas earnings.
The U.S.-China trade tumult remains a front-and-center issue
for many emerging market economies. Any resolution to the
issue would be critical not just for China, but its other Asian
trading counterparts like South Korea and Taiwan. As such, we
are cautiously optimistic for the status quo on the trade war and
no further escalations. We believe China has started loosening
policy on the domestic front and we anticipate an easing of
policy on regulations, monetary and fiscal side of things, which
should be supportive of the domestic economy. We already see
early measures that are supportive of the private sector, personal
consumption and infrastructure spending and we think more
measures are on the way.
Impact of fiscal reform in several emerging markets
Source: Ivy Investment Management Company; selected emerging market countries.
Brazil is still in the early stages of a recovery from a record setting recession. Inflation is very much under control, which should allow Brazil’s central bank to keep rates lower in the near term. The president-elect, Jair Bolsonaro, takes office on January 1, 2019, with leadership elections for the upper and lower legislative bodies following in early February. The new administration has high approval ratings heading into office, and we believe it needs to enact fiscal reforms while the honeymoon lasts. Privatizations of state-owned companies will provide a budgetary buffer, but safety net reforms, like pension and social security, will require heavy lifting.
India continues being relatively more immune to trade-related headwinds elsewhere in Asia. The fall in oil prices offers a respite to country’s fiscal pressures that built up earlier in the year and pressured the rupee.
We believe Mexico and South Africa will face geopolitical
headwinds in 2019. Mexico’s incoming president, Andrés
Manuel López Obrador, has already proposed a host of marketunfriendly
measures like cancelling a construction project of
the Mexico City New International Airport.
Ongoing political scandals in South Africa are impeding the
economic reform efforts of President Cyril Ramaphosa. The
country is scheduled to hold general elections in 2019, which
could see the ruling African National Congress lose seats in the
national assembly. Elections also may impact fiscal and monetary
policies emerging markets in 2019, with India, Indonesia and
Turkey among the more significant countries to watch.
Equity valuations are another supportive theme in the backdrop for emerging markets. While not at extreme discounts in both absolute and relative terms to developed markets, valuations are below median versus historical levels. Overall, emerging market equities were trading at about 10 times 2019 consensus earnings estimates as 2018 came to a close, or about a 27% discount to developed markets.
Amidst this backdrop, we believe the economic outlook for emerging markets, while challenging, still looks brighter. We expect a slower pace of Fed rate hikes and the slightly softer dollar to ease some of the pressure on emerging markets, giving local central banks a chance to ease rates or take a less aggressive stance on rate hikes. The recent agreement to cut oil production by the OPEC-plus group appears as a positive in the immediate term, but will take several months to see if the proposals actually take effect. We expect to see additional fiscal stimulus in China at some point in 2019, but the timing and magnitude should be dictated by ongoing negotiations between Beijing and Washington. The recent agreement to cut oil production by the OPEC-plus group appears as a positive in the immediate term but will take several months to see if the proposals actually take effect.
2019 Outlook — What’s ahead amid slowing growth
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