2Q 2020 US Equity Outlook: Looking to upgrade portfolios amid turmoil
Jin Zhang portends that now is a good time to allocate to emerging markets. Major EM countries can survive the short-term effects of a stronger dollar and have adhered to fiscal discipline. Jin anticipates resilience in e-commerce, online entertainment, IT services and memory chips.
Emerging market equities sold off significantly late in the first quarter. Each market and sector within the MSCI Emerging Markets index was down. While the energy sector was the hardest hit, we saw quite indiscriminate selling, including consumer-oriented names which should be resilient in an economic downturn.
Under these conditions, investors must triple-check their investments. There are essentially three types of businesses: those that will be challenged short term and long term; those challenged short term but which should recover, and those companies that are less affected short term and which should actually do better in the long run. We think investors should focus on the companies that fall in the second and ideally the third categories.
Online retailers like Alibaba and entertainment companies like Tencent have held up well during the lockdown in China. As restrictions are lifted, we expect that consumers will have formed new habits and these businesses will have gained new customers for the long run. Large numbers of people working from home has also put pressure on companies’ IT capacity. We expect demand for cloud-based services to continue to increase following the crisis, in turn driving demand for memory and logic chips.
Investors need to consider the short and long-term effects of the liquidity squeeze in emerging markets. Many EM countries have learned their lessons from past crises and recognized the need to issue debt in local currency rather than US dollars. They are therefore in a good position to survive the short-term effects of a stronger dollar. Brazil is a good example with over 90% of its government debt predominantly issued in local currency. Over the long term, many emerging markets have also learned the importance of fiscal discipline. Major emerging markets that have maintained fiscal discipline are good places for investors to be.
China entered the crisis earlier and thus been emerging earlier. As a result, some stocks have performed relatively strongly. For example, Chinese bank stocks have benefited from government policy to extend rather than foreclose loans. However, we believe that there are better opportunities in other sectors.
India’s lockdown response may be different in major cities than in rural areas, as many millions still live a hand-to-mouth existence. In its favor, the country has a young population with a low proportion of over-65s. Investors will need to look closely at the long-term prospects of businesses they own. However, there are strong companies in sectors like IT services, which are less exposed to the domestic market and are providing critical support for businesses around the world.