Emerging markets (EM) have been out of favor for some time. This asset class, which encompasses a diverse range of countries and economies, has suffered amid heightened geopolitical uncertainty, a strong dollar and the economic disruption from China’s now abandoned ‘zero-Covid’ policy.
While short-term factors have diminished EMs’ appeal for many investors, here are four reasons why longer-term structural change means they may need to be on the radar for anyone looking to diversify1 her holdings:
Energy transition
Many EMs are associated with the production of soft (coffee, wheat, soybeans) and hard (metals, oil, gas) commodities. The global energy transition – a shift from carbon-intensive fuels to low-carbon alternatives – may put EMs at the center of delivering key commodities for many more years.
While the steel industry helped build modern America more than 100 years ago, industrial metals, such as copper, zinc, aluminum, and nickel, may play a similar role this century. Countries in Latin America and southern Africa are key producers. Demand for some precious metals may also increase due to their role in reducing carbon emissions in car engines.
China, whose companies account for almost one-third of the investable EM universe, is a world leader in some of the new technologies – solar capacity, batteries and electric vehicles – that lie at the heart of the sustainable-energy revolution.
US climate regulation
Last year’s Inflation Reduction Act (2022) was the biggest piece of federal climate legislation in history – worth almost $400 billion over 10 years.
Academic experts estimate it will lead to reduced US emissions by some 32% to 42% below 2005 levels by 2030 – between 5 and 15 percentage points more than would have been achieved without it.2
Its focus on energy security and tackling climate change swings the spotlight onto areas such as nuclear power, hydrogen and other forms of cleaner power. It may also put into place long-term incentives for more investment in solar, wind and energy-storage technologies.
All this may have significant implications on the demand for commodities – many produced by EMs – that are linked to renewable energy and the energy transition.
China’s back in business
Late last year, China quietly abandoned its ‘zero-Covid’ policy that had caused severe disruption to its domestic and international economic activity.
Despite rising geopolitical tension, the world’s second-largest economy must play a key part in any global recovery (short-term inflation concerns aside). It’s especially important to other EMs given China’s role as a major consumer of commodities and services, and its role in the global supply chains in which EMs form a vital link.
That said, it’s hard to predict the precise short-term effects on global demand of China’s return. It’s like driving through a dark tunnel and seeing the light ahead. However, it’s still a shock when you emerge into the sunlight, no matter how much you anticipate it.
Growing EM demand
Domestic consumption has become a bigger driver of EM economic activity within the last decade. More recently, consumer demand has undergone a process of ‘premiumization’ – as wealthier consumers seek out higher-quality products and services.
This domestic consumption has also driven the rise of consumer discretionary businesses, such as the big Asian e-commerce companies, that have their equivalents in the US.
There are lots of well-known companies in this space, particularly in countries such as China. While recent regulatory obstacles have dampened their attractiveness, these firms may continue to be an important driver of EM growth in the years ahead.
Final thoughts
Even though EM assets haven’t performed very well over the past couple of years (mainly because of poor sentiment around China), selected commodities provided a few bright spots in the markets last year amid conflict-induced shortages.
The short- to medium-term outlook for commodities could be supported by a weaker dollar since the start of this year (as many key items are traded in dollars). Supply-chain disruptions linked to the conflict in Ukraine, and renewables investment to tackle the climate crisis, may also help.
But over the longer term, the role of EMs in the supply of key commodities that may support the energy transition, as well as their rising stature a source of demand for global goods and services, may ensure their growing importance in the systemic changes that are under way.
2. Source: REPEAT Project (based at Princeton University); Rhodium Group; Energy Innovation, August 2022
IMPORTANT INFORMATION
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.
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