Market views: Coronavirus’s impact on emerging markets
The further spread of the Coronavirus has jolted global markets, sending major benchmarks into correction territory. Emerging markets, obviously, have taken the hit of the panic-induced selloff as investors seek out safe assets in a risk-off mode.
The MSCI Emerging Market Index, for example, has dropped over 8% over the past week. Poland's WIG20 Index and Thailand's SET index are among those that have thrown up the worst performances; they have fallen 17.73% and 15.78% year-to-date as of March 2.
This has challenged the positive outlook that investors and managers alike held before the virus spread from Asia to other continents. China, South Korea and Iran are among the top five countries that have posted the highest number of confirmed cases, which stood at 80,026, 4,212 and 978, respectively, as of March 2 (Monday).
Ivan Li, CSL Securities' director of investment research, previously told AsianInvestor that the revival of emerging markets will possibly "not be realised" now.
This could, however, translate to buying opportunities too. UBS said in a report that the price-to-book valuations of Asia ex-Japan stocks have fallen below the historical average of 1.6x, while the discount to developed markets stocks has widened to around 35%, up from the historical average of 23%.
This week we have asked investment experts how institutional investors should approach emerging market investments given the global spread of the Coronavirus?
In particular, are there red flags in any areas in emerging markets? What are the medium- to long-term investment possibilities due to market corrections?
The following extracts have been edited for clarity and brevity.
Jean-Charles Sambor, head of emerging market fixed income
BNP Paribas Asset Management
There have been several phases of market development within emerging market debt since the Coronavirus outbreak came to light in early January.
The initial reaction was relatively muted, especially within credit, both sovereign and corporates. Spreads remained broadly stable until mid-February, before widening sharply from around 300 basis points (bp) to more than 345bp in a couple of days. This was a very unusual move, especially given the improving trend in China. We view this as an overreaction.
There is a genuine risk of a significant slowdown in growth, although this should prove temporary and/or could be combined with aggressive monetary and fiscal stimuli. We, therefore, think it is too late to reduce risk and that this dislocation could provide some opportunities. Even an abrupt fall in growth doesn’t change the credit risk profile of these markets. We think we are nearing the point at which there will be a sharp rebound in emerging market risk appetite, prompted by fears subsiding.
Local-currency emerging market debt has sold off, but we see potential for a rebound within three to six months as capital flows return to emerging markets on cheap valuations. However, the recent rally in local interest rates – especially in lower-yielding markets such as China, Korea and Thailand – looks overdone.
In the next couple of months, we wouldn’t be surprised to see higher yields in these countries, especially Korea and Thailand, as the consensus is now extremely bearish on growth and inflation. On the other hand, higher-yielding markets could recover their losses as they do not suffer from structural imbalances. Indonesia is a good example.
Aditya Monappa, Asia-Pacific managing director for multi-asset and alternatives
Alliance Bernstein
The first part of 2020 has been difficult for global markets – with bouts of volatility driven by the spread of Covid-19 throughout both the developed and emerging world. Moving forward, we are likely to see some downward revisions to growth and earnings estimates but, with emerging market governments and central banks so quick to lend support, the longer-term impact could be somewhat softened.
Also, it’s important to remember that much of the economic data leading up to the outbreak was improving, which suggests that markets were beginning to look past the growth concerns that they had last year. Year-to-date, we have seen huge stimulus packages offered by Chinese authorities and other emerging marketss such as Thailand, Malaysia and Indonesia in an attempt to cushion the impact of the virus.
Against this backdrop, we maintain our constructive view on emerging markets – but remain mindful not to concentrate exposure too heavily on a specific area of the capital markets. Periods of heightened volatility such as these, highlight the importance of taking a diversified approach to investing – we feel that having a strategic mix of both equities and bonds is critical to ensure adequate downside protection during times of market stress.
At a sector level, more cyclical areas of the market such as commodities and industrials could face the largest headwinds – along with travel-related stocks that will suffer from the obvious reduction in the movement of people around the globe. On the other hand, the short-term postponement of activities triggered by the Coronavirus could lead to longer-term structural shifts that could create opportunities for new companies to thrive.
For instance, we’re in the midst of the largest ever working-from-home experiment in China and parts of Asia, where people are having to rely on remote technological services more than ever before.
Chetan Sehgal, director of portfolio management for emerging markets equity
Franklin Templeton
The most important thing investors can do right now is not to panic. The global spread of the virus and interdependence between economies as a result of interlinked supply chains and tourism means that the outbreak cannot be considered a localised issue to China or even Asia. We have seen developed and emerging markets fall in tandem.
Despite weakness in the short-term, we believe that the outbreak should eventually be contained as authorities take steps to combat the spread of the virus. We have already started to see a fall in daily new cases in earlier-impacted countries such as China. We expect others to follow a similar tapering pattern. We could even see a faster-than-expected recovery given the strength and resolve of the scientific community.
The resilience and geographical divergence of emerging markets should not be overlooked. Structural themes remain unchanged as information technology and consumers play key roles. While we have seen weak consumer sentiment impact discretionary purchases and travel; e-commerce, internet and software companies are benefiting from an increase in online activities, and a recovery is likely in semiconductors because demand and supply has been delayed but not denied, and technology evolution continues. We do, however, expect a slower recovery in consumer discretionary expenditure.
We think one should be careful in investing in over-levered firms and could avoid them at this juncture. Investors should also look at companies that could benefit from any permanent behavioural changes in society as technology is likely to be more strongly embraced. Investors need to be more mindful of companies that are excessively leveraged. Government policy should remain supportive in the interim as policy-makers take actions to support impacted segments of the economy.
Over the long-term, history has shown us that markets will stabilise and recover. Valuation and sustainable earnings remain key.
Clifton Hill, portfolio manager for multi-asset class strategies
Acadian Asset Management
Institutional investors can have a higher probability of success by maintaining a diversified and dynamic allocation strategy that can weather shocks such as the recent Coronavirus. Diversified means diversification through positions, assets, asset classes, factors and themes. Dynamic means cross-asset factors that can quickly change to identify stresses and opportunities in the marketplace.
Additionally, by identifying the structurally weaker countries and assets to be underweight or short, versus the stronger countries and assets to be overweight or long, investors gain an opportunity to generate alpha in both risk-on environments similar to early January and early February of 2020, or risk-off environments such as late January and late February of this year.
Investors don’t have to avoid emerging equities and currencies, but rather use a range of factors to identify the weaker emerging assets versus the stronger emerging market assets in a long/short manner. Investors should also pay close attention to all global and emerging market central banks for insights on how to adjust dynamically to each country’s assets as the various scenarios develop. We believe remaining diversified and dynamic in a return-seeking manner is the way to withstand the challenges of volatility around market shocks such as the current Coronavirus fears.
Irene Goh, Asia Pacific head of multi-asset solutions
Aberdeen Standard Investments
The coronavirus outbreak is poised to deliver a material disruption to the global economy in the near term. The policy reaction within China should help to support a recovery: authorities there have been easing monetary policy marginally, and we expect them to expand fiscal measures further. Any loosening of monetary policy in the US should also alleviate pressures on liquidity conditions in emerging markets in general, which should benefit local government debt markets.
We had been adding to positions in countries such as Indonesia, South Korea and China in our multi-asset portfolios as opportunities present themselves and for reasons unrelated to the virus developments, although this is accompanied by other risk hedges and diversifying strategies. Our overweight to emerging market debt has not only been a tactical play, but also a strategic one, given persistent low yields in developed markets.
We also see pockets of value in emerging market equities due to the tailwinds of monetary policy and reasonable valuation levels. Uncertainty about the macroeconomic outlook, however, has been on the rise and a V-shaped global recovery in the second half of 2020 is now a pre-requisite to avoid a lengthy global economic contraction. If that fails to materialise, we could see further market stress.
To construct resilient multi-asset portfolios able to withstand a range of potential market shocks, it is important to offset and hedge risks appropriately. Moreover, we test our portfolios based on a number of forward-looking scenarios, which helps us to balance risk and prepare for unusual market events such as this Coronavirus outbreak.
Previous market views on the coronavirus outbreak:
How will the Coronavirus infect markets?