The new paradigms of EM Equities

The outlook for emerging markets is one that is driven by a series of underlying forces namely the emergence of the middle class in Asia, the rising impact of climate change and a changing manufacturing and service landscape.

The rise of the Middle Class in Asia
Sometimes it is not possible to get the timing right, but out of the noise we can see a picture of what is coming. In this case, we see the emergence of a new class of consumers all across Asia and with it the rise of a service industry from financials to healthcare. This is especially so in China and Northern Asia, increasingly in Southern Asia and – to a lesser extent — Latin America. A developing country grows quickly not only because it offers a cheap labor force, but because it can quickly upskill its workforce to produce ever more sophisticated goods for an ever better paid and productive workforce. Some countries will better manage this transition with the likes of Argentina on the difficult side and China on the other. Southern Asia and Mexico are expected to benefit even more from the outsourcing of production away from China of increasingly sophisticated products.
Climate change will play an increasing role
Carbon border taxes should mean that some countries such as China, Malaysia and India have a strong incentive to weaken their currencies to reduce the costs of climate change on their economies. Imagine that they pollute and that the EU imposes a 20% carbon tax on them, then letting their currency devalue by 20% would wipe out the cost of the carbon tax. In retaliation, pollution importers like the EU will certainly force a rejigging of production away from these countries to those that are climate change friendly. According to the UN’s Environmental Performance Index (EPI) carbon taxes would help Japan, Australia, South Korea and Russia. However, other countries especially Vietnam, Brazil, Malaysia and Indonesia could make very rapid progress from very poor rankings.

The receding tide of liquidity
One key concern as the Fed moves towards tapering is what this will mean for Emerging Market equities. Much of this is expected but Fed and central banks in developing countries’ monetary tightening policies mean that those economies may cool down more than expected. The good news is that over a period of months, demand will cool enough for global inflationary pressures to subside, namely via

  • Lower pressure on the supply chain and
  • Less of a price wage inflation spiral.



Hence, some volatility in EM equities is still likely particularly as we are still unsure yet about the depth of the Chinese slowdown.

What does it mean?

EM equities are cheap (see Graph) and a buy on dip but mostly from the point of view of positioning for secular trends. This is an exercise in patience waiting for new paradigms to develop, very much as it took years for the ESG to spread worldwide from Europe.

Source: Nordea Investment Funds S.A. and Bloomberg

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