St James Place : What is the outlook for emerging markets

• Investing

29 Jun 2022

3m read

Emerging markets have had a challenging year. What is the outlook for the region, and how should investors think about them in the context of their broader investment portfolio?

At a glance

• Economic growth across the world is slowing, and emerging markets are facing their own set of challenges
• Some regions have benefitted from rising commodity prices, and the waning effects of COVID-19 are aiding recovery
• Volatility and risk are generally higher in emerging markets, so it is important for investors to diversify across other equity regions and asset classes when seeking long term returns

'Emerging markets' is often mentioned when talking about investments - but what does it actually mean?

Emerging markets are countries that are becoming fully developed economies. Although there is no universally agreed list of countries that fit within this category, the term usually refers to around twenty countries, most notably China, India, and Brazil.

These countries can have a higher rate of economic growth, but investing carries increased risk, as there's often less regulation and tighter liquidity.

What role do emerging markets play in a portfolio?

Emerging markets offer the prospect of higher returns compared to developed markets - but they can be volatile.

To that end, emerging markets are typically suited to investors with higher risk-appetites, and a long-term outlook. They're also usually held as part of a diversified portfolio, which can smoothen out some of their volatility.

How have emerging markets been performing?

Emerging markets have had a difficult last twelve months. The MSCI Emerging Markets has fallen considerably further in contrast to the MSCI World Index.

COVID-19 took a heavy toll on emerging markets - partly because a larger proportion of their output is based on manufacturing. This meant that when governments introduced restrictions on social contact, workers could not as easily work from home, so many companies simply stopped production altogether.

The good news, however, is that the impact of COVID-19 on manufacturing is being reversed. As factories reopen and production lines restart, manufacturing is beginning to recover.

Another reason why emerging markets have struggled in the last year is Russia's invasion of Ukraine.

Russia is a significant producer of commodities, including oil and gas. Sanctions on commodity imports from Russia have caused inflationary pressure across the world, as can be seen in rising fuel prices.

This is causing issues with manufacturing, where almost every good and service produced requires energy, from power required to run machinery to simply keeping the lights on in an office block.

Emerging markets feel this squeeze even more due to their high manufacturing output. For example, in China manufacturing made up just over a quarter of the countries GDP in contrast to just 15% in the Eurozone in 2019 according to the IMF.¹

As a result, emerging markets have experienced a greater decline in total output than in developed economies.

Food security

The war in Ukraine has also caused food prices to rise. Russia and Ukraine produce over a quarter of the world's wheat between them². As the war has threatened this supply, prices have risen.

If consumers are required to spend more on food, then this leaves them with less money to spend on other goods, meaning a contraction in the domestic economy. In emerging markets, where disposable incomes tend to be lower, a higher proportion of income is spent on food, thus the effects of food inflation are felt more. The World Food Program (WFP) estimates that someone living in New Delhi spends on average 3% of their daily income on a plate of food in contrast to just 0.6% spent by someone living in New York.³

How are emerging markets expected to perform?

The outlook for emerging markets is not all doom and gloom. Countries that export a large amount of commodities are benefiting from price rises. This means that although some emerging markets may pay for inflation, others will benefit.

Even with the impact of COVID-19 beginning to wane, and manufacturing recovering, the market remains a challenging investment environment. This is where active managers can really provide value, as they use their expertise and skill to find buying opportunities and look to find quality businesses that may outperform the wider market and be resilient in the face of economic headwinds.

With these active managers, for investors that can tolerate the additional risk and volatility, emerging markets can play a role as part of a well-diversified portfolio - as economies are likely to bottom out and recover at different points, having exposure to a variety of regions, sectors and styles may help you benefit from the eventual turnaround in markets.

Past performance is not indicative of future performance.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

Sources:
¹ IMF world bank data hub, 28 June 2022
² OEC, Exporters of Wheat, 2020 (June 2022)
³ UN World Food Program, counting the beans, 2020

Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.