Like those almost everywhere else, emerging markets (EMs) suffered a coronavirus shock in March.
Having plunged by nearly a third in the early part of the month, however, EM share prices partly recovered towards the end. Promises of large-scale monetary and fiscal stimulus in the US arrested the declines, but EM stocks still had a torrid start to 2020. As a group, they ended the first quarter down 23.6% in US dollar terms. On the other hand, when we look at them in isolation, China’s A-shares were more resilient. Despite China’s status as the source of the pandemic, they fell less than half as much.
China has moved quickly to bring the virus under control. While a few other EM countries, especially in Asia, have gone into lockdown early, a number have been slower to respond. And so we expect that even while most EMs are ramping up containment measures, coronavirus will continue to spread.
Sources of support
The US is not the only country whose government and central bank have acted to counter economic damage from the virus. Aiming to prevent a downward spiral into a financial crisis, central banks have given major cash injections to markets. Meanwhile, regulators have been easing capital rules for banks and governments are offering sizeable loan-guarantee schemes.
But monetary and fiscal stimulus in EM economies has so far been muted compared to their developed equivalents. EM central banks have been more willing to loosen policy than in the past. In an environment where investors are less accepting of risk, however, there is pressure on many EM currencies. So the central banks have to try to counter capital flight, too.
The US Federal Reserve (Fed) has stepped in with some external help, however. It has provided emerging markets dollar liquidity where foreign central banks can use these swap lines to exchange US Treasuries for dollars.
For most EM countries, the inflation backdrop has been benign in recent years. But imported inflation, a potential effect of currency weakness, could be a worry for some central banks. Two factors should allay fears, though. The first is the sharp drop in the oil price. The second is that we think it’s likely that Covid-19’s impact will be disinflationary.
Importantly, many EM countries, companies and households are in better financial health than they have been at the start of previous crises. For most of Asia, the drop in the oil price is a positive. While oil-rich countries are suffering, some – such as Russia and its National Wealth Fund – have buffers to help offset periods of low oil prices.
Importantly, many EM countries, companies and households are in better financial health than they have been at the start of previous crises.
We are most comfortable with our equity exposure to China. The country gives us a map to the road ahead. Extreme containment measures will control the spread of the virus and allow activity to slowly return to normal, but there will be upfront economic pain. At the time of writing, there have been very few new cases of Covid-19 reported in most areas. Meanwhile, factory production has largely resumed. Shanghai is almost back to business-as-usual, with shopping and traffic levels gradually increasing.
Technology trends such as Cloud, AI and 5G are all accelerating with the shift to working from home. There is strong momentum from gaming companies and social networks, with increasing user engagement. Finally, due to the widespread lockdowns, there’s been an even bigger shift away from bricks and mortar towards e-commerce businesses.
What’s priced in?
Overall, we think that EM equities have moved into value territory. Nevertheless, the likelihood is that economic data in the months to come will reveal a severe negative shock. And for some EMs, coronavirus is still in the early stages of spreading. Taking all of this into account, we expect volatility to continue.