In India, newly crowned the world’s most populous nation, large domestic investment in infrastructure is bolstering manufacturing and attracting foreign investment. Samsung already has operations in India and continues to invest. Taiwan-based Foxconn Electronics, an Apple supplier, is planning a US$200 million facility for producing AirPods in India, marking a big vote of confidence in the country’s manufacturing capabilities.
That investment illustrates how globalization is changing. Investors who can identify the next big reshoring destinations and industries will be able to capture attractive opportunities as the map of global manufacturing is redrawn.
3. China’s Common Prosperity Policy Redefines Growth
As China’s population has become richer in recent years, the government has become more sensitive to a widening socioeconomic gap. In August 2021, President Xi Jinping said that common prosperity, “rather than being egalitarian or having only a few people prosperous,” referred to “affluence shared by everyone.” Xi seeks to increase per-capita income and to reduce inequality across income groups and regions. The agenda covers many areas, from more balanced development to boosting productivity, income and infrastructure.
As part of these efforts, China has taken regulatory action in recent years against certain industries. These moves rattled markets, and for some investors, undermined confidence in investing in China, as regulatory moves are unpredictable.
We think that’s the wrong conclusion. In our view, regulatory uncertainty can be mitigated with a better understanding of the interplay between the government and private sector in China.
Certain types of Chinese companies will benefit from the policy priorities. These include companies that can navigate the commercial and ideological priorities, and businesses aligned with the government’s agenda. Companies that cater to less-wealthy customers may also have an advantage. Instead of forgoing China’s significant return potential, we think investors should develop a strategy that aims to reduce regulatory risk and identify opportunities in a growing economy that is forecast to become the world’s largest by 2035.
4. Green Investments Will Generate Commodity Demand
Alongside common prosperity, China is also pursuing an ambitious green reform agenda. China, the world’s largest CO2 emitter, aims to reach peak carbon emissions before 2030 and is targeting carbon neutrality by 2060. India is also targeting net-zero emissions by 2070.
Achieving these ambitious goals requires massive investments in wind and solar power, EVs, smart power grids and other green technologies. Companies that enable China’s green agenda will benefit from the policy. Many of China’s green enablers are major suppliers around the world and will enjoy an impetus from the global energy transition.
Building climate resilience is, paradoxically, a commodity-intensive endeavor. Copper, nickel, cobalt, lithium and rare earths are essential ingredients in renewable energy equipment and EVs. China is a major supplier of many of these minerals, along with Chile, Argentina, Indonesia and Estonia. Commodity-producing EM countries should enjoy a boost from the energy transition.
Active Investors Can Find Advantages in EM Inefficiencies
Positioning for the potential EM comeback won’t be easy. Investors must be alert to the differences between EM equity markets and their DM peers.
Many EM stock markets are dominated by retail investors, which makes them less efficient than DM markets. Some are dominated by foreign investors, who may be quick to flee in a crisis or when the asset class is out of favor. There’s also less information available about many EM stocks than DM stocks, which makes them more prone to emotional swings.
These issues aren’t new. However, investors might have expected EM market behaviors to converge with DM’s. In fact, we’ve seen the opposite. China A onshore and Saudi Arabian markets are among the more retail-dominated in the world and are becoming a larger part of the broader EM index. As a result, EM markets in aggregate are becoming less efficient, in our view.
Inefficient markets are often illiquid. Yet EM stock markets offer an uncommon combination of liquidity and inefficiency—an attractive combination for stock pickers. When stocks are hit by a market overreaction, active investors can find opportunities in mispriced shares of companies with resilient long-term potential. We believe that EM stocks provide especially fertile ground for active managers because of the equity markets’ behavioral features and the attractive growth potential of a broad spectrum of companies.
What Will It Take to Unleash Return Potential?
EM companies should enjoy strong tailwinds for growth, in our view. Across the developing world, rising incomes, urbanization and government policies aimed at promoting economic growth leads more people into higher income employment. With more income, the middle class begins to spend on products and services that it couldn’t afford previously. Domestic reforms, manufacturing growth through reshoring and technological progress all support sustainable middle-class growth. And the socioeconomic forces that persuade people to pursue a better life are even more powerful today, in a world where easily accessible online information broadens the appeal of premium products and services.
Constraints on EM equity market performance may be starting to ease. Currency dynamics look favorable, China is reopening its economy after pandemic lockdowns and EM growth is poised to widen the gap with DM growth, after the differential narrowed in recent years. In aggregate, developing economies are almost as large as DM economies, yet EM remains underrepresented in global equity indices. The time is right for investors to revisit their EM exposures within global equity allocations and build a long-term strategic plan that is designed to capture the next phase of the developing world’s growth evolution.