Emerging markets will be boosted by vaccine roll out and weaker US dollar

20 December 2020

Emerging markets continue to hold their appeal amid the development of a Covid-19 vaccine and a weak US dollar, according to RBC Wealth Management.

With the vaccine are now beginning to be rolled out, RBC head of investment strategy Frederique Carrier says this will be positive news for emerging markets.

“One can be forgiven for thinking that as the vaccines are initially rolled out in advanced economies, EMs stand to lose out. But that is not necessarily the case. Many EMs, including Thailand, South Korea, and Turkey, rely heavily on exports, accounting for a hefty 60%, 40%, and 33% of GDP respectively. So, as the global cycle picks up, these economies should benefit. Countries like Thailand, Mexico, and Turkey, could enjoy an incremental recovery on the return of freshly vaccinated tourists.”

Carrier said that despite earlier concerns that the Covid-19 outbreak could spark a financial crisis among emerging markets, with a wave of defaults and devaluations, these fears have proved overblown. According to the Organisation for Economic Co-Operation and Development, emerging market Asia will top the economic growth leaderboard in 2021 driven primarily by China, which is expected to grow 8% in 2021, with India expected to grow by 7.9%.

Meanwhile, the prospect of a weaker US dollar will also help boost emerging markets, according to Carrier.

With global confidence ticking up as a result of vaccine breakthroughs, the performance of the dollar has fallen. Since the peak of the Covid-19 crisis in March, the dollar has weakened by some 12%, with forecasts expecting weakness to persist into 2021.

As investors gain confidence in the global economic outlook, they will likely seek higher-yielding assets, says Carrier. The fourth quarter is already shaping up to be one of the strongest quarters for inflows into emerging markets since 2013, with non-resident portfolio flows totalling some $76 billion in November.

According to RBC Wealth Management, emerging market currencies are nearly as undervalued as they were during the Asian financial crisis, despite some countries’ balance of payments surpluses reaching a near 20-year high.

Carrier said: “Strengthening EM currencies and undemanding equity valuations underpin a constructive case for EM equities. Historically, there has been a distinct positive relationship between strong currencies and equities. Our national research correspondent finds that over the past 15 years most EM equities have outperformed as currencies in these countries strengthened.

“EM equities also appear undervalued. On a sector-adjusted price-to-earnings basis, EM equities trade at a discount of some 20 percent to developed markets, close to a 15-year low, with most sectors trading at a discount to their developed market equivalent.”

Carrier adds: “Overall, we believe that the prospects for EM equities look attractive for 2021. They’ve had a good run recently, surpassing their year’s high, achieved in January, and the MSCI Emerging Markets Index is up 67% since the March lows, in line with the gains generated by the S&P 500.  On a one-year view, we are positive on the asset class, with a preference for Asia (ex-Japan), and China in particular. Having weathered the COVID-19 crisis more successfully, this region’s finances make it less vulnerable to an eventual Fed tightening cycle.”

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