Political volatility and pandemic-related risks have dominated news headlines recently. Meanwhile, the global economy has quietly been on the mend.
After a deep recession in the second quarter as governments across the world locked down their economies to contain Covid-19, growth is bouncing back strongly and a new economic cycle has started.
The initial stage of the global economic recovery was explosive, supported simultaneously by reopenings as well as huge amounts of stimulus thrown at economies. On the fiscal side, this involved various forms of support for workers and companies hit by the pandemic while Western central banks supported financial markets by buying or guaranteeing an unprecedented range of official and private types of debt.
This recovery will inevitably slow down from here, and there are a large number of uncertainties looming towards the end of this year – the US election and a possible Covid-19 resurgence sit atop the list. The positive trajectory of global economic growth continues to march ahead, though, with ongoing official stimulus ready to be deployed until a coronavirus vaccine is made available.
That should be a good environment for emerging market stocks dominated by the Asian export powerhouses such as China and South Korea, which are highly dependent on the health of the global economy. Together these markets account for nearly 70 per cent of the emerging equity universe.
This has only partly played out so far this year. The MSCI Emerging Markets Asia Index is up some 12 per cent, only a little bit ahead of the USA Index’s 9 per cent and the All-Country World Index at 8.5 per cent.
However, Asia has done much better than the other regions that are usually lumped into the emerging markets category alongside it. Latin America is down by over a third year to date and the Europe, Middle East and Africa region is down by more than 20 per cent.
This hints at Asia’s ongoing change in characteristics. It is no longer just rich in highly cyclical manufacturing businesses that cater to demand from Western consumers and businesses. It is increasingly also a home for leading growth industries such as information technology.
For instance, the weight of the information technology sector in the Emerging Markets Asia Index is 23 per cent. That is second only to the US index, which comes in at 29 per cent.
These sectors have emerged as winners from the Covid-19 crisis, which Asia has handled much better than other regions, giving it a degree of protection during the recession earlier this year.
It is no coincidence that Asian equities did not underperform the rest of the world during the market collapse in March and April, as they probably would have done in past recessions. Instead, they largely performed in line with other regions during the collapse and outperformed, if only mildly, during the market recovery.
Put another way, the region provides an attractive mix of cyclical exposure to economic recovery as well as to today’s structural growth themes.
What about other macro drivers? Asian stocks and broad emerging market stocks generally perform better with a weaker US dollar, which allows local central banks to keep interest rates low.Signs here are promising with the US growth forecast looking less impressive compared to the rest of world in 2021 and safe-haven demand for the US dollar likely to weaken once the US presidential election is behind us.If challenger Joe Biden does win the US presidency, as looks increasingly likely judging by opinion polls, it should at least lower the risk of another trade war with China even if disagreements remain. That would help sentiment towards Asian markets and possibly boost trade volumes.
One headwind for the region might be valuations. Asian stocks are no longer cheap, especially after the strong summer rally in China helped drive price-to-earnings ratios to their highest level since 2010.
However, those ratios have risen across most regions, and Asia looks to be average compared to the rest of world.
Despite all the worries, Asian equities and emerging market equites in general should reap the benefits if the global economic recovery continues in the coming year.
