There are four main drivers that will influence how global emerging markets perform over the long term, says Michael Reynal, a portfolio manager at Sophus Capital, which sub-advises the Renaissance Emerging Markets Fund.
Here’s a breakdown of those drivers and how they’re affecting developing markets.
1. Demographics trends
The populations of emerging markets are still growing, says Reynal — a contrast to many other parts of the world.
He explains, “The population pyramid [for these markets] is positive and you’re seeing a growing younger population, in particular. That is not the case in most of the developed world,” especially in Japan, and even in Europe and North America.
2. Increased globalization
The growing populations of emerging markets has, in part, helped boost globalization. Reynal mentions the globalization of trade, manufacturing and services.
Regarding services, Reynal points to a Brazilian dentistry company that he recently analyzed. That company outsources x-ray analysis by sending images to doctors in India for faster, overnight reviews.
“That, to me, is extraordinary—that the world has become so small that you can use cheaper labour around the world to expedite [such] processes, [moving them] from one emerging market to another,” says Reynal.
This is an example of how globalization isn’t just about manufacturing, he adds. “It’s also about trading. And, that global increase in trade has net-net been positive for jobs, both in developed and emerging markets.”
Reynal notes, “The globalization of manufacturing has led to specialization and improvements in productivity both in the developed and the emerging world.”
3. Financial intermediation
Financial intermediation, and the global integration of financials, relates to how emerging markets seek funding and banking support.
As Reynal explains, what’s driving these markets is “the fact that the U.S. dollar is one of the key metrics. Most emerging market financial systems are too small to support the scale of industry [that] they have. To put it simply, a large mining company in Peru cannot access enough financing in Peru to implement a multi-billion-dollar expansion.”
As a result of financing challenges, many emerging market economies source funding globally, he adds, “and frankly, the same is true for most emerging market governments. That means there is a very strong link between emerging market financing trends and the [U.S.] dollar and, to a certain extent, the euro and the yen. This is translated into domestic banks and banking environments.”
But one consequence of financial globalization, says Reynal, is more sensitivity to global events. “As individuals and small companies in India, Indonesia and/or Brazil get more access, they in turn are starting to be impacted by what’s going on globally.”
4. Consumption trends
Consumption of a wider range of services and products by emerging markets is increasing, says Reynal, who points to the healthcare and real estate industries as well as to new technologies.
Consider this: “Apple’s largest market outside of the U.S. is now China,” he adds. “And the emerging market consumer is not just [looking] for cars and scooters and phones, but also for financial products [and] healthcare products. This is a global revolution.”
Short-term trends to watch
Along with the above four long-term drivers, there are short-term trend to monitor, says Reynal. “We need to focus on the [U.S.] dollar and [whether] a more dovish Fed is going to lead to a continued weak or stable dollar,” he suggests. “This [would be] very good for emerging markets.”
Already, he finds, “we’ve seen a stabilization of commodity prices and, in fact, oil has bounced off a low last year below $30 and is now trading in the mid-$40 [range]. That’s mostly good for emerging markets.”
Reynal is also monitoring China’s economic growth. “China is such a large part of global growth today. This time last year, in the second half of 2015, people’s expectations for China were very negative. They’re now neutral to positive, and that will continue to support the emerging market story.”