Key Tailwinds

Key tailwinds for emerging markets now

August 19, 2016
Ivy Emerging Markets Equity Fund


Story Highlights

  • By 2030, there could be 5 billion consumers in the world with the majority in emerging markets.
  • Emerging market equities valuations still are trading at a discount to developed markets.
  • We expect the stabilization in oil prices will be particularly beneficial for oil-exporting countries.

Global economic growth still is slow overall, but many emerging markets continue to outpace the developed world. In addition, emerging market equities have outperformed developed markets through mid-2016. We think investors should consider an allocation to emerging markets as part of a diversified portfolio.

Evolution in global economy

The term “emerging markets” was coined in 1981 to change the perception of economies and markets in developing countries, which make up 80% of the world’s population and 75% of its geographic area.

In general, we think there are four main features in emerging markets that differentiate them from developed economies:

  • low household incomes,
  • ongoing structural changes, such as modernization of infrastructure
  • progress in economic development reforms,
  • less-mature markets in terms of regulation and liquidity.

As household incomes rise, more people are moving into the middle class in emerging markets. Their spending patterns tend to change with the rising income, going beyond subsistence into discretionary goods. By 2030, there could be 5 billion consumers in the world with the majority in emerging markets.¹ Those consumers already are having a significant impact on global consumption and the demand for energy, technology, housing, health care, education and more.

Variety of supporting factors

A combination of factors has prompted investor interest in emerging market equities in recent months. An end to the U.S. dollar rally and a slow recovery in energy prices have provided two strong tailwinds. Those were joined by uncertainty after the U.K.'s vote in June to leave the European Union ("Brexit"), the onset of negative rates on an estimated $13 trillion of sovereign bonds, and persistently low inflation with slow growth in the U.S. and other key developed markets. In addition, emerging market equities valuations still are trading at a discount to developed markets, compared with historical averages. For example, emerging market equities on average recently traded at about 10.9 times projected 2017 earnings versus about 14.6 times earnings for developed market equities.2

That means many emerging market equities are trading at what we still consider attractive valuations while many developed market equities are trading above historical means. History shows that the gap is likely to narrow at some point, but we believe the current levels create opportunities now.

As we look at countries around the world in more detail, we believe geopolitical events will continue to cause market volatility through the balance of the year. The resolution of the Brexit issue, the pace of future interest rate increases by the U.S. Federal Reserve (Fed) and the U.S. presidential election are likely to be among the most important influences on emerging markets in the near term. It's worth noting that we do not think the Fed will increase interest rates in the foreseeable future.

We remain selective in investments in China, where President Xi Jinping’s ongoing anti-corruption campaign is delaying the implementation of broad-based reforms in the state-owned enterprises (SOE). We think these are needed to continue to build opportunities for business to develop outside the SOE structure. We are watching the SOEs for signs of a policy change.

We expect the stabilization in oil prices will be particularly beneficial for oil-exporting countries. In our view, Russia and Brazil can begin to generate positive gross domestic product growth in the coming quarters as a result of steadier oil and other economic improvements in each country. It also appears that inflation has peaked in Russia, where the central bank has begun to cut interest rates. We believe Brazil is only about six months behind in this process.

A closer look at the fund

We are pursuing several key themes as we research and select securities for the Fund now, including:

  • The burgeoning middle classes in emerging market economies.
  • The growing levels of consumption that accompany that trend.
  • The updating and expansion of new growth drivers such as energy, new energy vehicles, health care, biosimilar pharmaceuticals, technology and education.

There is a tendency to think of emerging markets as a single potential investment option, but there are many variations among these countries. We think it’s critical to analyze each country’s fundamentals and idiosyncratic risks, and to analyze it sector by sector in order to make an investment decision.

We think potential opportunities may continue in the near term from lower oil prices and ongoing reform programs in many emerging market countries. Given the variations and volatility of each individual market, we believe an active management approach is the best way to invest in equities in these markets.

1 Source: Brookings Institution Press, “China’s Emerging Middle Class: Beyond Economic Transformation”

2Source: market data

Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s portfolio manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 2016, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

Diversification does not guarantee a profit or protect against loss in a declining market.

Risk factors:The value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investments in countries with emerging economies or securities markets may carry greater risk than investments in more developed countries. Political and economic structures in many such countries may be undergoing significant evolution and rapid development, and such countries may lack the social, political and economic stability characteristics of more developed countries. Investments in securities issued in these countries may be more volatile and less liquid than securities issued in more developed countries. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

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