Emerging markets and industrialised countries are following different recovery paths in the post-pandemic phase. Unlike developed countries, emerging markets generally do not have sufficient fiscal space to implement large-scale economic support and recovery programmes. And because of their difficulties in coping with the new wave of the pandemic, analysts expect these countries to face much greater income losses in the coming years than those expected in developed countries. While for the latter the average loss of income per capita from 2020 to 2024 compared to the pre-crisis level is estimated at 2.3%, it is 4.3% in emerging countries. It even reaches 6.1% if China is excluded from the comparison. This is bad news for emerging countries, as it affects domestic demand as an engine of growth.
But should we ignore these markets? Patrick Zweifel, chief economist at Pictet Asset Management, does not think so, even though he expects emerging economies to underperform their developed counterparts over the next six quarters, "a rare situation in recent history". For him, "the economic environment should remain very favourable for emerging market assets". This is primarily due to the rebound in inflation, "the friend of emerging markets".
The world is entering one of those favourable periods of high inflation and strong growth in which emerging assets thrive.
"Emerging market asset classes perform best during periods of high inflation and strong growth. They are among the best performers across all asset classes. Over periods as far back as 1950, when global inflation was over 2% and global GDP growth was above its four-year average, emerging market equities outperformed a list of 25 major asset classes by a wide margin, with average annual returns well above 20%.
Emerging market debt is following this momentum. "Unhedged emerging market local currency bonds generated an average annual return of around 14%, more than double that of US Treasuries and well ahead of other debt instruments, with the exception of high yield credit, which tends to be closer to equities in terms of performance. And while dollar-denominated emerging sovereign debt lagged its local currency counterpart, it still outperformed developed market government bonds and investment grade credit."
Zweifel thinks that inflation is not a temporary phenomenon. “It seems increasingly likely that the era of low inflation is behind us. Therefore, it makes sense to position against such a risk,” by staying in the emerging markets in particular.
Growth still on track
The second reason is that even if growth is lower than in the developed world, it will still be there. "The four main drivers of emerging market growth are all in the green: global trade is booming; commodities are booming; China remains robust; and the dollar looks set to weaken, which is also a plus for commodity price developments and lower debt servicing costs for emerging borrowers.”
The big question is the risk of rising US Treasury yields, which means destabilisation for risky assets.
"In fact, historically, the most favourable environment for emerging assets is characterised by strong emerging market growth that coincides with rising US bond yields."
Originally published in French by and translated for Delano