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After their lows in March and April 2020, stock markets have defied even the most gloomy economic statistics. However, scratch beneath the surface and it is clear that there is a polarisation: a handful of stocks have led markets higher, while a long tail of companies has been left behind. This has been pitched as a growth versus value debate, but in reality, companies showing compelling growth have also been neglected – and particularly those in frontier and smaller emerging markets.
The top-performing technology companies have had some tailwinds as economies have been forced to lock down. Businesses and individuals have been forced to embrace digitalisation, ecommerce and remote working, which has supported the earnings for these companies. As such, investors have understandably gravitated towards these giant companies in uncertain times. However, it has left some extraordinary valuation anomalies.
Disparities in valuation
Salesforce.com has grown to be worth more than the entire stock market of Chile. Indonesia, with its 275m people, trades on valuation less than a third of Nvidia1. All the listed companies in Vietnam, $262bn economy, are apparently worth the same as Netflix1. No-one would suggest that these are bad companies, the question is whether there should be these vast disparities in valuation.
This would be unusual in itself, but many of the economies on which we focus also display compelling growth characteristics. For the year ahead, we expect many to grow at 6-8% with economic indicators such as retail sales, purchasing managers’ indices and balance of payments improving significantly over the past few months. We see earnings and cash flows for many of the companies in our portfolio growing at a steady 10-15% a year.
Yet investors have appeared disinterested and this has prompted some de-rating in the shares of many companies within frontier markets. Price to book ratios remain at a significant discount to their 10-year average1. Today, the valuation of the Indonesian markets sits at a 26% discount to its long-term average, while the Philippines sits at an 18% discount1. For Chile, it’s 20%. In contrast, the S&P 500 sits at a 47% premium to its long-term average1.
A shift in sentiment
Why might this change? We certainly see a shifting attitude towards emerging markets. Emerging markets have caught up and surpassed developed markets since the lows of March and April 2020. To date, most of this growth has come from China, but we believe this should broaden out over time as confidence grows in the recovery and investors see the growth potential for many of these economies.
While developed markets are likely to see growth constrained by the higher debt burdens accumulated to deal with the virus, frontier markets haven’t been able to raise debt, which is likely to leave them in a better position longer term. To our mind, this is likely to give them a resilience not matched by the world’s major economies.
It is also worth considering that at a time when environmental, social and governance considerations are increasingly on the mind of investors, these economies house 3bn of the world’s poorest people2. Equity capital is vitally important in helping these economies grow and develop, improving living standards and providing jobs. If investors are looking to do good with their capital, this seems a reasonable place to start, rather than directing money to areas where there is already abundant wealth.
At a time when the world is short of growth, bypassing these fast-growing markets is an oversight. Ultimately, once valuations become too extreme and the growth too compelling to ignore, we believe international investors will start looking once again.
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This material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are from BlackRock as of February 2021 and may change as subsequent conditions vary.
1 Bloomberg, January 2021
2 IMF WEO, October 2020
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Trust Specific Risks
Exchange rate risk: The return of your investment may increase or decrease as a result of currency fluctuations.
Emerging Europe risk: Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation.
Frontiers risk: The Company invests in a number of developing emerging markets (“Frontier Markets”). Frontier Markets tend to be more volatile than more established markets and therefore present a higher degree of risk as they are less well regulated and may be affected by political and social instability and other factors.
Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
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