Where to find growth in emerging markets

Despite geopolitical risks and high-profile crises in Turkey and Argentina, there’s still a strong case for investing in emerging markets.

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Emerging market growth is expected to slow in the second half of 2018 compared with the previous year, from 5.1% to 4.8%, said Michael Reynal, chief investment officer and portfolio manager at Sophus Capital in Des Moines, Iowa.

But that level of growth is “not too shabby,” he said in a mid-September interview. The slowdown is primarily due to laggards in Eastern Europe and in countries “most susceptible to capital flow” such as Turkey and Argentina.

The International Monetary Fund has significantly cut its forecast for Turkey’s GDP growth to 3.5% for this year and 0.4% for 2019, compared to growth of 7.4% last year. Interest rates rose to 24% (625 basis points) in September, while inflation reached a 15-year high of almost 25%.

Other regions are doing well and looking to improve, he said, and he hopes to see a turnaround in two major Latin American economies. “We’ve come through a difficult political cycle in Mexico and we’re going through that political cycle in Brazil today,” said Reynal, whose firm sub-advises the Renaissance Emerging Markets Fund.

GDP growth in Russia and in smaller European markets such as Hungary is likely to pick up for the rest of 2018 and into 2019, said Reynal.

While political upheaval is always a risk in emerging markets, the risk is lower than in previous decades, Reynal added. “We are not seeing many revolutions,” he said. “Elections are happening surprisingly cleanly and access to these markets—and travel and exchanges—are happening quite openly.”

China’s slowdown 

China’s economy is unquestionably slowing, Reynal said, and this reversal of growth “has fixated the world.”

This will affect global trade and commodities that feed into the infrastructure of China, he said. “We are not so worried about that,” he said, since a slowdown would still mean GDP growth of  6% to 6.5%. “Not such a dramatic move,” he added.

Also, most of China’s growth is internal and driven by consumption, the rise of the middle class and by the expansion of credit across the middle class, Reynal added.

U.S. dollar dip would be a boon

In the meantime, the developed world “has had a sharp pickup in growth driven by the United States in the first half of 2018,” he said. He expects that to continue this year, though he forecasts a slowdown in 2019.

One main reason for strong U.S. growth has been the effect of President Trump’s tax cuts, Reynal said. The U.S. economy grew at a robust annual rate of 4.2% in the second quarter—the best performance in nearly four years—and major banks have recently reported strong results, for example.

As that effect wears off, and as continued deficit spending weighs on the country going forward, the greenback may suffer. “This could be positive for emerging markets,” Reynal said, since they’d then be more competitive.

Reynal is also concerned about regionalization or the division of nations across the globe. As the U.S. takes on less of a global leadership role, other countries “will have to stand a little bit more on their own two feet when it comes to security” and be more competitive economically, he said.

“On the other hand, we will also see more integration […] in certain [emerging market] regions and certain trade pacts,” Reynal added. “We’ve already seen this in Asia and it’s been a huge positive. We’ve seen this become part of some of these economies’ long term strateg[ies].”

Reynal highlights China’s One Belt, One Road initiative: a government-supported project that aims to connect 70 countries throughout Asia, Africa and Europe through infrastructure such as railroads and shipping lanes.

“I expect to see this not just in Asia with China, but increasingly across Europe—linking Eastern and Western Europe—and I hope to see this in Latin America as well,” Reynal said.

Overall, he’s positive about emerging market growth. “While there can be volatility, these are very attractive parts of the world,” he concluded.

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