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Unleashing the power of innovation in emerging markets

Please see the below article from Invesco received over the weekend:

Key takeaways

  1. Innovation is not just about technology
  2. Not a one size fits all approach to finding opportunities
  3. ESG and innovation are both driving change

Innovation in emerging markets is no longer about applying technologies and techniques from developed economies to play catch to the levels of productivity, income and wealth that took centuries to achieve in the United States or Europe.

Instead accelerating innovating is becoming a driver of growth. Our panellists in the ‘Emerging Markets: Innovation Unleashed’ webinar discuss what is underpinning the fast pace of innovation and how it is evolving.

Many emerging markets countries have a strong track record when it comes to innovation. China has overtaken both the United States and Japan in the number of patents being awarded and for many years, Russia has exceeded the number of patents won by Germany and the UK, while India has recently surpassed them as well.

“Innovation has also shaped consumption patterns in Asia and China,” said William Yuen, associate director of investment at Invesco in the Asia Pacific region.

Yuen has put this down to the rapid adoption of the Internet across Asia. Enormous opportunities have opened up for companies wanting to create innovative products for a digital consumer audience.

On the back of this wave small social media platforms, digital payment platforms and entertainment companies have been turned into mega companies.

But the concept of innovation expands much wider than technology and the Internet. Yuen explained companies are not just innovating for digitalisation, rather research and development has evolved and other consumer broad themes have emerged that are driving change and creating investment opportunities. These include premiumisation, experience, urbanisation and wellness.

“A lot of the spending nowadays is no longer just about getting things done or day-to-day survival,” said Yuen. “It is a lot about experiences.”

As consumers demand more, companies are converting existing products into more sophisticated ones to get a higher margin for the return on their businesses.

To find the companies disrupting the market, Bhvatosh Vajpayee, director of equity research at Invesco specialising in emerging market equities, pointed out there are four major ways investors could do this.

First is to look at the scale of the market. For example, India, South East Asia and Latin America have large pools of consumers. Second is to understand how user adoption and developmental gaps can create leapfrog opportunities.

Third is to find localised solutions as countries differ widely on adoption curves and regulations. Lastly is examining local talent and ecosystems. In China, India and Russia local talent pools in science and engineering are particularly strong.

“Every country, every region is very idiosyncratic,” said Vajpayee. “The one lesson that we have learned over the last few years is do not take the template from one country and try to fit it in some other country.”

Innovations were also driving the adoption of ESG principles at the country level and at a sector level.

“These address decarbonisation, clean water and sanitation, climate change mitigation and digitalisation of course,” said Claudia Castro, director of fixed income research in the Invesco global debt team.

For example, as gas demand fades over the next decade, Russia will potentially have a problem as its pipeline capacity becomes redundant, pointed out Castro. Carbon capture and storage facilities have been looked into as a solution to this.

Speaking about the trend of ESG related innovation, Castro said: “We will not see it reversing, but accelerating.” Climate change is a global issue and countries need to recognise it at a local level.

“You have issues of infrastructure damage, displacement of people, food insecurity from disruptions from climate,” said Castro. “It is really important you have local solutions as well.”

This article again highlights what we have been talking about for the past year, ESG innovation is accelerating.

Emerging Markets is a section of the global markets that can offer the potential for real growth. These markets and the developing countries also have an opportunity to be ahead of the curve when it comes to ESG too by each playing to their own strengths, whether this be market size or technology advances.

Emerging Markets is definitely a sector to watch and include in your portfolio for the potential for some good long term returns.

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

12/07/2021

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Invesco: Emerging markets, China, and the road ahead

Please see below for one of Invesco’s latest investment articles, received by us yesterday 07/07/2021:

A year and a half after the first reported cases of a new SARS-like virus in Wuhan, China, we can now look back with greater clarity on a period of some of the most dramatic volatility since the Asian and global financial crises. Here, we assess what this volatility and the associated policy responses have meant for China and emerging markets and plot a dotted line for the road ahead.

Looking up after locking down

At the time the pandemic hit, the unresolved US-China trade war loomed large and global manufacturing was in the early stages of restructuring to accommodate new trade patterns. Despite this, China stood out from other countries in terms of its fiscal, monetary and industrial policy response.

Beijing’s policy decisions focused on maintaining domestic productivity and employment with as little disruption on the demand side as possible. Manufacturers were given liberal access to capital to maintain operations, and refunds on social security tax and unemployment insurance incentivised businesses to retain staff without layoffs.

At the same time, the central bank lowered its reserve requirements and removed blocks on certain loan extensions and renewals. Investments were made in traditional infrastructure projects like housing and transportation, and spending on the nationwide 5G network was accelerated.

As a result, China moved from having a GDP contraction of almost 6% for the first quarter of 2020 to being the only major world economy to print a positive GDP growth number for the year.

A dolorous relationship?

While China’s growth in 2020 is unmatched, the road ahead is not unwinding, particularly when we consider the impact that US policy decisions could have on the US dollar.

The growth of the US fiscal balance sheet in 2020 (accommodated via easy monetary policy) appears to have stimulated real inflation in the US economy – an outcome which has led to talk of tightening. If asset purchase programmes are tapered or rates increased, the likely outcome is a stronger dollar.

Historically, a strong dollar has been negative for emerging markets, as it increases the burden of US dollar-denominated debt. This is less of a factor today than it was prior to the Asian and global financial crises. However, the fact remains that this could dampen growth prospects in some emerging market economies.

Commodities buck the trend

In spite of the observation noted above, it is likely that a stronger dollar will benefit firms selling commodities into US dollar-denominated markets, as long as there is global demand for these products. This factors into the dramatic outperformance we have seen from steelmakers, iron miners, commodity chemical companies, and even coal producers.

The demand behind this outperformance is not part of the same super-cycle seen after China’s admission to the World Trade Organisation, when investment in capacity and infrastructure facilitated the country’s transition to the so-called ‘world’s factory’.

Even when we account for the fact that some of this capacity has moved to other countries in the context of trade realignment, the overall demand for commodity materials is not in the same league as two decades ago.

Instead of a broad, sustainable growth in demand, we are seeing a short-term build-up of inventories that reflects ‘new normal’ uncertainties about tariffs and pandemic lockdowns. This goes all the way through the product cycle, from raw materials to finished goods.

Although these dynamics are almost certainly near-term and should subside in the medium-term, they do attract speculation that disrupts the market.

The road ahead

What does this disruption mean for emerging markets? In the absence of significant inflows, there is a conservation of capital within the asset class. The sharp and transitory shifts described above get funded by parts of the market that have outperformed — in this case growth companies, in particular those in China. In this sense, China has been a victim of its own success as far as its response to the pandemic is concerned, as some investors look to lock-in potential gains.

That said, in our opinion, these sharp transitions do not signify a change in the long-term view for emerging markets. The types of firms that create and capture value for shareholders remain the same.

Even with an ageing population, China remains a large economy with an outlook for sustained, high-speed growth. The growing middle class offers opportunities for investment in education, real estate services, and world-leading innovative technology platforms that facilitate consumption.

It is worth adding that the size and scale of the domestic market should make it less susceptible to external volatility than other markets in the asset class.

What these transitions offer, then, is the potential to invest in the best long-term opportunities at more attractive valuations than normal market conditions afford. 

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well.

Paul Green DipFA

08/07/2021

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Will US dollar weakness last?

Please see below for Invesco’s article regarding the US Economy, received by us late Friday 05/02/2021:

A weak US dollar is commonly seen as a benefit to international stocks as foreign companies’ returns appear more attractive in dollar-denominated terms. So it’s no surprise that, as an equity strategist, I’m often asked about my outlook for the US dollar.

After a dramatic “risk-on” rotation beginning in early 2020, we greet the new year with a technically oversold US currency and overbought stock market. In other words, investor positioning has become lopsided, arguing that a countertrend bounce in the “greenback” and near-term drawdowns in stocks may be in store.

Looking further ahead, however, I believe the “buck” should continue to depreciate for a host of reasons, and expect the current weak dollar cycle to last for years to come.

A history of US dollar cycles

The trade-weighted US dollar Index measures the value of the United States dollar relative to other major world currencies. Since the early 1970s, the relative value of the US dollar has ebbed and flowed between long and well-defined periods of strength and weakness. As illustrated in Figure 1, it seems the “greenback” is only four years into the current weak dollar cycle. On average, such cycles have lasted about eight years, the longest having been roughly 10 years.

Figure 1. It seems the “greenback” is only four years into the current weak dollar cycle

Factors that support a weak US dollar

While past dollar cycles can offer clues about what the future may hold for the currency, history isn’t enough on its own. As such, I assembled a number of other factors that I believe support a weak dollar, including:

  • Valuations suggest that a swath of international currencies are trading at substantial discounts, especially in emerging markets (EM), meaning that they may have more room to strengthen compared to the dollar.
  • The Federal Reserve remains firmly in  monetary easing mode, which means the path of least resistance seems to be downward for the US currency. If quantitative easing (QE) represents a choice between the economy and  the “greenback,” the Fed has opted to save growth and jobs by opening the spigots and inflating the monetary base at the expense of the currency. From a long-term perspective, I think it’s reasonable to expect the US dollar to weaken further should the Fed keep such an abundant supply of currency in circulation.
  • The deep economic impact of the coronavirus pandemic has necessitated counter-cyclical government support to an unprecedented degree. In turn, ballooning twin deficits have become stiff fundamental headwinds for the US dollar. Why? When the US spends more than it earns, it floods the global financial system with US dollars, placing downward pressure on the value of its currency.

My recent chartbook – Seven reasons for a weaker US dollar and stronger international stocks – takes a deeper dive into these factors, as well as other reasons why I believe we may only be halfway through the current weak US dollar cycle.

Investment implications

In a global context, currency dynamics are an important component of investors’ total returns. For example, EM currency strength (the flipside of US dollar weakness) has boosted dollar-based investors’ returns on EM stocks (priced in US dollars).

Why have EM stocks moved in the same direction as their currencies? It’s a virtuous, self-reinforcing “flow” argument. Before foreign capital can flow into EM stocks, foreign currency-denominated assets must be sold in exchange for EM currencies.

Apparently, improving fundamentals versus 2015/16 have made the emerging market economies a more attractive destination for foreign capital, and the Fed’s dovishness is helping the situation.

For investors, this isn’t just an EM story. It’s a bigger message — one that I believe has positive ramifications for international stocks more broadly.

Learning about major players in the markets such as the US and their effect on the global markets as a whole can be useful and keep your holistic view of the markets up to date.

Please continue to check our blogs section for articles like these.

Keep safe and well.

Paul Green

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Legal & General: Our Asset Allocation team’s key beliefs

Please see below for Legal and General’s latest Asset Allocation Team’s Key Beliefs article received by us the afternoon of 25/01/2021:

Bubble trouble?

Never have more people searched for the term ‘stock market bubble’ on Google. Data stretching back to 2004 show that January 2021 is set to eclipse January 2018, when searches for the term both preceded and followed a 10% drop in the S&P 500 over nine trading days. As we have highlighted before, investor optimism is pretty well inflated and, while most sentiment indicators don’t look stretched, many are elevated.

Burst case scenario

Not everyone is optimistic, though. One scholar of market bubbles, Jeremy Grantham, opened his new outlook: “The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble.” Grantham has a good track record in predicting the moments when bubbles burst, so should we be worried? We think the famed investor may be right but, as he concedes, we believe the market could still run a lot further. Our own bubble index shows that the probability of a market bubble has indeed been rising. In fact, it is now the highest it has been since 2008.

What has driven this? We have seen an increase in capital raising through IPOs and SPACs, some of which echo the tech bubble of the late 1990s. US retail investor activity has also taken off, with easier access through investment platforms and, for some, new money to play with from stimulus cheques. However, we are just emerging from the COVID-driven economic recession. This means many macroeconomic indicators have improved, policy is supportive, and there is plenty more cash on the side lines ready to be deployed, regardless of further fiscal stimulus.

So while the market is definitely reminiscent of a bubble forming, it could easily still get much stronger from here. We therefore believe it’s too early to call a bubble now.

The moderates yield

If you weren’t able to watch any of the US presidential inauguration, I recommend viewing US National Youth Poet Laureate Amanda Gorman’s recital of “The Hill We Climb”, a powerful and gritty poem of hope for the future of the US, from a self-proclaimed presidential candidate for 2036.

In the more immediate future, the most relevant aspect of the new Biden administration to financial markets will be the prospect of more fiscal stimulus. The central case is for another virus relief package worth $1 trillion to be passed in the coming months, with an additional $1 trillion recovery package potentially following later. The quicker the economy recovers, of course, the smaller later packages will be.

Politically, though, we see the path of least resistance actually being for more fiscal spending rather than less. With a razor-thin majority, power accrues to the moderates, which means only consensus policies can pass. We expect it will be easier to build such a consensus on extra spending (giving things away) than on extra revenues (taking things away). While Democratic moderates have supported virus relief and the current package so far, several are not on record as supporting Biden’s tax proposals. Finally, voters don’t appear to care as much about deficits anymore, so senators probably won’t either.

Treasury yields could be the place where changing fiscal dynamics are priced, and indeed US yields have risen more than others in recent weeks after the Georgia runoffs, but as it stands we are comfortable with an overall neutral position on duration. In fact, we prefer US markets to UK gilts, which have only seen more modest yield rises despite the so-far successful vaccine rollout and expectations for a fiscally conservative budget.

Flexible recipe for fixed income

Multi-asset portfolios are like giant cakes, baked with multiple ingredients. We have decided to add a new ingredient to our cake: Chinese bonds. Technically it’s not new, as they are a growing part of emerging-market bond allocations in portfolios, but we have moved to an explicitly positive view.

We believe Chinese bonds add a lot of diversification to our fixed income holdings as China hums to a slightly different economic tune from the rest of the world, with a different monetary policy framework too. Historically, Chinese bonds have had a low correlation to other bonds. Their yields are relatively high, and we are particularly interested in bonds that could continue to provide protection in macro downturns as we believe many traditional bond markets will struggle to provide the defence they offered in the past.

This is just one of the steps we have been taking in portfolios to try to manage investor outcomes in a low interest-rate environment, with greater roles for non-traditional fixed income assets as well as defensive currencies and other strategies.

Regularly ‘picking the brains’ of investment managers and experts by reading articles like these can help update your own view of the markets and current global affairs.

Please keep reading these blogs to keep your view of the market well informed and up to date.

Stay safe and well

Paul Green 26/01/2021