Derrick Irwin, portfolio manager for Allspring’s Intrinsic Emerging Markets Equity team, and Ann Miletti, head of Active Equity and chief diversity officer, discuss emerging markets and why they might be one of the best areas to invest in this year. A more complete discussion can be found in Allspring’s midyear report to investors.


Derrick Irwin: As we look at the landscape, we’ve seen very significant changes on the ground in EM (emerging markets) that really can drive some pretty exciting investment opportunities.

Ann Miletti: That’s Derrick Irwin, portfolio manager for Allspring’s Intrinsic Emerging Markets Equity team. I’m Ann Miletti, head of Active Equity and chief diversity officer at Allspring, and you’re listening to On the Trading Desk®. With all that’s happening in the economy and equity markets in just the first half of this year, many investors are probably wondering what’s in store for the rest of 2023 and where potentially promising equity investments could be found. Today, Derrick will share his thoughts on emerging markets and why they might be one of the best areas to invest in this year. Thanks for joining me, Derrick.

Derrick: Hi, Ann. Good to be here.

Ann: Maybe it’d be helpful if we set the stage for the current economic environment for emerging markets. We all hear so much news about political unrest in a lot of the markets around the world, what they’re experiencing, and maybe you can talk about the current environment and how that might differ from the past.

Derrick: We really need to start with China, which entered the year on a really strong note having abandoned their zero-COVID policies in late 2022, setting off significant recovery and economic growth there. However, since, that growth has turned out to be a little more lopsided than investors hoped in the sense that it’s largely been domestic driven, largely been consumption driven, whereas industrial production, exports, and the very critical housing market have been a little softer. But, nevertheless, we are seeing a very real and sustained recovery in the Chinese economy as 2023 goes on. The second thing that we’re seeing is a continued moderation in inflation. Emerging markets, arguably, were hit by inflationary pressures earlier than the developed markets and are exiting their inflationary period probably a little bit earlier. And, so, we are looking forward to rates coming down in emerging markets. Brazil, for example, in 2021, saw inflation spike well into the double digits, into the teens. And now that inflation has come down below 5% and we would expect the central bank in Brazil to begin cutting rates there. And that can set off a pretty virtuous cycle of both growth and, of course, equity price appreciation. And speaking of growth, as we look at emerging markets as a whole, what I think we will see through the rest of the year is continued accelerating growth at a period where the developed markets are arguably slowing down. And that gap in growth with emerging markets growing more strongly and developed markets perhaps slowing down is often a very good signal of strong equity market performance in emerging markets. So, while there’s a lot going on in emerging markets, I think, on balance, it can be a pretty positive environment for the second half of the year.

Ann: I know that investors often look to the strength or the weakness of the dollar and what that role plays within the emerging markets, too. Could you delve into that a little bit more and why that, too, might be an opportunity now?

Derrick: Sure. We’re bottom-up stock pickers, right? So, I spend my day worrying about business models and margins and companies and whatnot. But the reality is the dollar is incredibly important to the trajectory for emerging market equity prices. It does appear that the dollar peaked last year after really about a 10-year bull run versus emerging markets. And it was a very significant drag for emerging market equities. And we think that certainly, if not reversing entirely, the drag the dollar could have on emerging market equities does seem to be dissipating. What I think we’re seeing is as inflation begins to fall in emerging markets, even as they begin to cut rates, we’re seeing much higher real interest rates in emerging markets. And with the Fed (Federal Reserve) close, hopefully, to cutting rates as the market seems to think they will, that carry trade or the appeal of higher real interest rates in emerging markets is something that should be very supportive of emerging market currencies versus the dollar. Again, not to pick on Brazil, but I think as inflation has come down in Brazil, investors have recognized that significant opportunity from a real rate standpoint. And in recent months, the Brazilian real has rallied quite sharply against the dollar. So, it’s always very hard and always very dangerous as an emerging market investor to try to outguess the dollar. But to the extent that we have seen the peak in the dollar, it can be very positive for emerging market equities going forward.

Ann: Yeah. Derrick, I know you and your team spend a tremendous amount of time focusing on bottom-up analysis, as you mentioned in the beginning. Maybe you can spend some time talking to us about what regions or industries you’re currently finding opportunities in.

Derrick: First, we have to look at China. It’s the biggest piece of our universe. It’s an incredibly important economy. And it’s been under significant pressure from a top-down standpoint. But from a bottom-up standpoint, we think there’s some pretty interesting opportunities. Gary Tan, one of our team members and a portfolio manager who sits in Singapore, was just in China and he likened the environment there to that old joke about three blind men looking at an elephant, right? Depending on which part of the elephant you’re touching, you get a very different view of what that elephant looks like. And China is no different. We’re seeing big differences in year-on-year numbers that may seal very good underlying fundamentals. So, as we dig deeper and deeper at the security level, there are some pretty exciting opportunities. Now many of them sit on the domestic consumption side because as global trade slows and as some of the exports slow, we are seeing a very strong domestic recovery. So, we’ve been able to take advantage of that, for sure. Outside of that, as I mentioned, Brazil is at an inflection point from a top-down standpoint and that’s creating interesting bottom-up opportunities, particularly on the domestic consumption side, which has been very, very weak for some time and we think will begin to recover through 2023 and 2024. And then one of the areas we’re looking at are companies that might be beneficiaries of what has been described as nearshoring, or onshoring, or the movement of supply chains, from China to other countries. Mexico, India, and the rest of Southeast Asia, as well, are clear beneficiaries here and we’re able to find interesting opportunities at the company level. And even beyond that, we believe that we are at the beginning of a significant shift in foreign direct investment, as China structurally slows, we expect Chinese companies to begin to shift their investment to other markets, such as Southeast Asia, Vietnam, etc., to take advantage of those faster-growing markets. And, of course, the West is looking for other areas of investment outside of China, which might certainly include Mexico, Latin America, and, again, Southeast Asia. So, we think those big-picture shifts in investment trends are going to be important, really for the next decade. And then, finally, from a sector standpoint, one of the areas that we’ve been focused on is how does artificial intelligence impact the emerging markets. And it’s very interesting because so much of the artificial intelligence supply chain sits in emerging markets, whether it’s the chip makers, memory in Taiwan, and Korea. And then as we look at the eventual development of artificial intelligence over the next few years, there really is a whole other ecosystem of software companies that potentially really can dominate the emerging markets ecosystem, which is very different than what we’re seeing in developed markets. So, that’s one of the areas we’re looking at that I think could be pretty exciting over the next year or so.

Ann: Maybe before we go, do you have any other parting thoughts you’d like to leave with us?

Derrick: Emerging markets have certainly struggled relative to particularly the S&P over the last decade. But if we look at emerging markets on a little bigger time frame, they’ve been able to add significant value for investors on any reasonable investing time frame. And I think as we look forward, we are seeing significant trends coming in place that may well benefit emerging markets. So, I think that as we look at the landscape, not just on a six-month basis, but on a three-year and five-year basis, we’ve seen very significant changes on the ground in EM that really can drive some pretty exciting investment opportunities. And the goal of our strategy is going to be to look on the ground and find companies that can benefit from those big macro shifts.

Ann: That’s great, Derrick. Thank you so much for being with us today and sharing your insights. I think it’s really important for us to all look around the corner and think about what’s possible in the next 6 to 12 months rather than just what is working today.

Derrick: Glad to be here. Thanks so much.

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