July marked the first month of the calendar year where emerging markets posted positive performance overall, with frontier markets leading the way. Manraj Sekhon, CIO of Franklin Templeton Emerging Markets Equity, and Chetan Sehgal, senior managing director and director of portfolio management, present the team’s overview of the emerging-markets universe and three things on their mind in particular today.

Three Things We’re Thinking about Today

  1. The left-wing coalition headed by Andrés Manuel López Obrador (AMLO) won by a landslide in Mexico’s general election. We do not expect a radical change in terms of Mexico’s fiscal or central bank policy as a result of AMLO’s win. Overall, we continue to have a positive outlook for the country. High consumer confidence, combined with a gradual disinflation process, a healthy labor market and credit availability, should help support private consumption this year. If the new administration can deliver on its promises and still preserve solid economic fundamentals, we could see healthy growth in Mexico this year and in 2019.
  2. The recent market correction across emerging markets has made valuations even more attractive, helping us find interesting opportunities related to secular technological trends. Growth in the e-commerce sector, for example, continues to accelerate, gaining an increasing share of the retail market in countries such as China and India. We believe the long-term growth of e-commerce companies hinges on their ability to scale and increase their market penetration. More importantly, these companies are using innovation to their advantage to disrupt traditional business models in other industries such as transportation and health care to pursue new revenue streams.
  3. We believe China’s deleveraging process has been more orderly than may appear at first glance. The fact that regulators allow banks to report non-performing loans reflects their confidence in the system’s ability to bear those losses. We remain positive on China’s overall growth trajectory. Some observers estimate that the trade war and other issues could shave up to 100 basis points off China’s gross domestic product (GDP) growth, but this is not much considering that growth is still expected to exceed 6% this year.1 We continue to favor companies that stand to benefit from structural trends like e-commerce, growing affluence and premiumization.

Outlook

Rising trade tensions, particularly between the United States and China, have prompted a cautious investor outlook, affecting emerging markets over the short term. However, we believe the market correction was overdone, and a widespread recovery could occur in the second half of the year. In our opinion, what has been hurting sentiment is not trade policy itself, but the uncertainty caused by escalating trade tensions. We believe businesses can adapt and develop long-term strategies around trade policies once there is greater clarity.

We consider fears regarding US dollar strength to be overblown. While a few countries such as Argentina and Turkey may have skewed overall investor perceptions, we believe that many emerging-market (EM) currencies are attractively valued and well-supported after recent downward moves. On the US dollar, short-term global risk aversion and a slight upward move in the US interest rate trajectory have contributed to strength, but we do not expect these drivers to be sustained over the long term.