Emerging markets stocks look attractive relative to U.S. peers, but not all countries within the asset class are created equal, says Daniel Graña, Portfolio Manager, Emerging Market Equity. Case in point: South Africa.

Key Takeaways

• Emerging markets (EM) stocks underperformed U.S. equities in 2019, helping improve the relative attractiveness of EM equities. However, as South Africa demonstrates, we believe investors should not paint all developing markets with the same brush.
• In South Africa, poor policy choices have led to a spike in government debt and double-digit unemployment, threatening the country’s credit rating.
• Meanwhile, other regions within EM, specifically Asia, are adopting growth-oriented reforms and innovating.

View Transcript

Daniel Graña: After a period of underperformance relative to U.S. markets, emerging markets look a little more attractive now. We are the home to better growth, we are home to some very exciting companies and I think it begs a question: Is it worth your time to look at opportunities in emerging markets?

Not all emerging markets are the same, created the same, starting points are the same. Some countries are heading in the right direction, and some countries are heading in the wrong direction. So, to say emerging markets, is actually a misnomer. There are parts of the emerging markets that look very promising, there are parts where policy choices undermine the story.

When evaluating countries, one that shows up on the negative ledger is South Africa. The policy choices taken over the last few administrations clearly have led South Africa in a more precarious situation. Government debt to GDP [gross domestic product] is rising, they haven’t solved a lot of the problems such as electricity shortages, education needs to change and improvement in skills.

The unemployment rate, the stated one, is over 30% now. The true unemployment rate is probably north of 45%. If you were to look at just youth unemployment, the numbers are even worse. And so, naturally, as this generation becomes a voting population, they are going to demand change. And my concern is that the kind of change that appeals to this generation is a lot more radical in terms of macroeconomic policy and it would lead the country faster in the wrong direction.

South Africa depends on foreign savings to balance its books. The problem is the confidence from the foreigners on the South Africa story is coming into question. The reforms that we expected to see under President Ramaphosa are not happening. There is a lot of resistance in the parts of the ANC [African National Congress], the ruling party, to a lot of these reforms that need to happen. And the concern, of course, would be that if South Africa goes deeper and deeper into debt, that all the rating agencies downgrade them to junk and that would potentially cause foreign investors on the bond side to sell. Unfortunately, given the very high foreign ownership of local government bonds, that would necessarily mean potentially an impact on the currency and that, of course, would spook equity investors as well. And so, my concern is that with this lack of commitment to reforms, that scenario is increasingly more likely.

Not all emerging market countries should be treated the same. Some certainly are making poor choices, limiting the investment opportunity. But there are others that are not, that are innovating, that are making their futures better. And investors should consider countries that are thinking about the future, thinking about how to navigate the very difficult global environment.

One region that investors should consider would be Asia. We are seeing innovation not only at the government level, but also at the company level. And so an investor should consider seriously opportunities in Asia.