A Strong June Pulled Emerging Markets Up in the Second Quarter
Trade issues continued to dominate headlines in June, with easing in US-China trade tensions providing a boost to emerging markets overall during the month. But Franklin Templeton Emerging Markets Equity cautions trade-related headwinds could persist. The team shares its latest emerging-market outlook and explains why the small-cap space looks attractive right now.
Three Things We’re Thinking About Today
- The United States and China agreed to resume trade talks at the G20 summit in late June. The United States also decided against imposing new tariffs and easing some restrictions on Chinese telecommunications company Huawei, while China agreed to substantial purchases of agricultural and other products from the United States. Although this truce has reduced the likelihood of further escalation in the short term, we expect prolonged discussions in view of the pending issues between the two countries. Markets globally—and especially the technology sector—reacted positively to the news. Meanwhile, in addition to diversifying its trading relationships, China in general has been turning less dependent on trade. In contrast, domestic consumption now makes up the lion’s share of China’s economic growth, accounting for 76% of gross domestic product (GDP) in 2018, up from 59% in 2017.1
Net exports, however, were a 9% drag on growth in 2018, compared to a 9% contribution in 2017.2 Further, with only 19%3 of Chinese exports destined for the United States in 2018, we have thus far seen limited impact from US tariffs on Chinese exporters.
- As widely expected, index provider MSCI promoted Kuwait to EM status in June. Kuwait’s MSCI Emerging Markets (EM) Index weighting is expected to be about 0.5% with implementation in May 2020. With substantial reserves, low levels of debt and a stable banking sector, Kuwait stands out in an EM context. Kuwait also continues to make significant progress in terms of fiscal and structural reforms and is committed to developing a dynamic and vibrant private sector. And while there is still some way to go, the results of Kuwait’s move to reduce the role of the public sector in the economy are encouraging, in our view. The country is moving away from oil dependence by developing its infrastructure, investing in human capital and promoting private-sector involvement. Despite trading at a premium to its EM peers, valuations in Kuwait remain reasonable, in our estimation. Moreover, we believe the earnings outlook for listed Kuwaiti companies supports a valuation premium. On a sector view, we remain particularly upbeat about Kuwait’s banking sector, which is showing improving profitability on the back of falling provisioning and improving asset quality.
- The EM small-cap space remains attractive to us. We continue to find investment opportunities in the health care sector, as well as companies that stand to benefit from long-term secular trends relating to consumption and innovation. Demographic shifts and aging populations in many EM countries are intensifying pressures on health care systems. In our view, these factors will continue to be a boon for hospitals, dietary supplements, medical devices and pharmaceuticals. The health care landscape is also changing, with growing consumer awareness fueling medical and wellness needs. We are seeing more consumers embrace preventive health care out of a desire to look and feel better. Rising domestic consumption also remains a long-term secular driver for EMs. EM companies have not only embraced the use of technology but have become global market innovators in many areas. We expect technology to continue to reshape EMs, as technology disruptors become the norm by transforming industry landscapes, and companies continue to embrace technology and innovation.