June 22, 2020: Live from the desk of our CIO, Piers Bolger

June 22, 2020: Live from the desk of our CIO, Piers Bolger

June 22, 2020: Live from the desk of our CIO, Piers Bolger 150 150 Piers Bolger

I’ve been asked quite a number of questions over the last couple of months as to whether or not we’ve been repositioning our global equity portfolios, and if we’ve had a greater exposure to developed markets over emerging market equities. The short answer to that is ‘yes’. We’ve certainly favoured developed markets over emerging markets.

But that hasn’t been something that we have positioned over the last three to six months since the global lockdown – it’s something that we’ve been repositioning over the last couple of years.

The chart below shows the relative performance between developed and emerging market equities. There are a couple of points to note around how we’ve been repositioning and how it’s really been over the last two years that we’ve started to do that.

As you can see in the first annotation, emerging markets started to have significant headwinds through the beginning of the US-China trade history, particularly through the early part of 2018, where developed markets continued to move higher. Secondly, the US Federal Reserve started to increase cash rates through 2018. While a negative for the financial market performance of developed markets, this created another leg-down for emerging market economies.

These changes came as a result of emerging market currencies actually starting to depreciate, as investors started to move out of emerging market currencies into developed market currency exposure, particularly the US dollar, on the back of higher cash rates.

So, throughout that period, we started to reposition our portfolios. We thought that the US-China trade dispute was clearly going to continue, and it could be a significant negative for overall financial market performance in emerging markets. Following this, we had COVID-19 and the associated global lockdown, which has caused a significant dislocation for the performance not only of developed markets, but also of emerging market economies.

Over the last eight to 10 weeks, we’ve seen a snapback in performance through equity markets more broadly – and within that, we’ve seen a stronger performance in developed, rather than emerging, market economies. We can identify several reasons for this.

First and foremost, the ability for governments to respond to the healthcare crisis has been greater in developed market economies. Infrastructure, including hospitals and other facilities, has clearly been under significant pressure globally. In emerging market economies, the government’s ability to be able to manage caseload and to be able to reopen at pace has been much lower than what we’ve seen in developed markets.

The second reason has been the ability of central banks within emerging market economies to be able to respond. Their ability to reduce cash rates – in order to provide the liquidity into financial markets and in turn, the support the financial markets need – has also been more constrained. In our view, this lack of liquidity has caused greater investor concern, which we’ve seen reflected in the comparatively low performance of emerging markets recently.

Now, will this change? And will it change our view as we head into the second half of this year into 2021?

In the short term, we don’t believe so. We believe the outlook for emerging market economies over that medium to long term remains very strong, given the potential growth rates we can see from those countries. But given that they are very much driven by exports, until we start to see the global trade flows starting to open and manufacturing beginning to normalise, we think that emerging market economies are still going to struggle relative to broader developed markets. This will ultimately be reflected in financial market performance.

Nevertheless, through 2021 and beyond, we think that there are some significant opportunities in emerging markets – particularly when we look at the valuations between emerging markets relative to developed market equity. And we’re certainly not out of emerging market equities. Not only do they provide an additional layer of diversification to portfolios, but we believe that potential upside is there. It’s probably just not at this point in time, or over the next three to six months into the early part of 2021.

But as always, we continue to monitor the situation and as we see opportunities arise, we’ll look to reposition portfolios accordingly.

If you have any concerns about your portfolio, please feel free to reach out to your advisor.

Piers Bolger is Chief Investment Officer at Viridian Advisory

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