3Q 2021 Emerging Markets Equity Outlook: Navigating Inflation Risk and Focusing on Sustainability

Navigating Inflation Risk and Focusing on Sustainability

Portfolio manager Jin Zhang addresses inflationary pressures and helps investors navigate Chinese and Latin American markets.

• Over the past twelve months, emerging market equities have produced solid returns, initially boosted by low interest rates, then by the economic recovery, and more recently by rising commodities prices. Returns in the second quarter were driven by cyclical sectors, including energy, industrials, materials and value financials.
• Inflationary concerns and tightening monetary conditions are impacting global financial markets. In the short-term, investors are rewarding more commodity types of businesses that benefit from higher prices or rates. However longer term, product differentiation and strong brand recognition are necessary to pass cost pressures on to consumers.
• Although Latin America continues to struggle with Covid-19, stocks have recovered somewhat in the region. However, Brazil has incurred more government debt vs. most Asian economies, which changes the country’s fight against Covid-19 from a short-term problem into a long-term one. Investors need to be selective about the businesses they are exposed to here by focusing on well-entrenched franchises.
• China is a growing pool of potential investments that has shifted from state run businesses to those run privately by entrepreneurs. While the pool is large, many businesses have shorter-term track records. Being highly selective and imploring ESG parameters as well as understanding businesses relationship with the government is key to finding long-term sustainable investments.
• The political backdrop for China is an important consideration and could face a coalition of international pressure in the future. It is important to focus on domestic businesses with strong fundamentals and understand changing supply chains.
• Risks have increased in certain areas of emerging markets and investors should be prepared for continued volatility in the short-term. But investors can find long-term growth opportunities and mitigate volatility by seeking quality businesses that benefit from structural growth drivers.

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