Emerging Markets, commodities, and the return of inflation may be key investment themes for 2021, writes Rainer Michael Preiss.

Emerging markets (EM), historically, have been considered higher risk and more volatile than the so-called developed markets of Western Europe, Australia, Canada, and the United States.

According to Bloomberg data, Korea’s KOSPI, with +33% YTD Return this year, is the best performing stock market in the world and South Korea has handled the Coronavirus pandemic better than some Western countries.

Next year and post the Coronavirus pandemic, however, we could see the outperformance of commodities- and commodity-led equity markets like Russia, due to a rise in inflation expectations in 2021.

The most important question in the world right now is whether the 40-year trend of disinflation is ending and whether the return of inflation could become a stronger market narrative in 2021.

Rainer Michael Preiss, Portfolio Strategist

A temporary bust in inflation is one of the key market risks for 2021 as the global economy recovers from the global Coronavirus crisis.

In my view, commodity-led emerging markets and the return of inflation are hence the most interesting and important macro stories and investment cases to watch for investors in 2021.

When I started out in the investment business in the mid-1990s emerging markets were still often considered as the “dark corners of the global economy”.

Emerging markets were a polite way of saying “poorly run and corrupt countries”.

Today, however, some EM offer good fundamentals and increasingly better governance and are the growth engine of the global economy. South Korea is a good example. COVID-19 has ravaged many economies all over the world but not South Korea.

Half a century ago, South Korea was statistically rated as ‘one of the poorest countries’ on Earth, and nobody would have predicted that it would conjure up an economic miracle. In 1960, its per-capita Gross Domestic Product (GDP) was US$158 slightly less than that of Ghana’s.

Albeit, its 2021 GDP per head on PPP is forecasted to stand at US$44,530.

According to Bloomberg data, South Korea’s KOSPI Index is the world’s best-performing equity market YTD with +33 % and the country often makes up 8 to 9% allocation in well-diversified emerging market funds.

A weaker U.S. dollar is spurring foreign investors to pour money into emerging-markets.

According to the IMF, RCEP (Regional Comprehensive Economic Partnership) could be a boon to the South Korean economy and could lead to a revival of Asia-led growth, and investment and correspondent demand in commodities.

The term Emerging markets may be coming to the end of its shelf life as a meaningful category. Here’s why:

• Index valuation methodologies for emerging markets are flawed.

• The prospects for different emerging markets vary widely.

• The opportunity set is too large to be treated as a homogenous asset class.

According to the Managing Partner of Golden Equator Wealth/Multi-Family Office Business and Head of Golden Equator Capital, Gary Tiernan, when it comes to allocating capital to emerging markets as an asset class “it is important to be selective”.

Experience tells us that one needs to be very much on top of the different markets – macro data, FX, politics, trade flows, investment flows, etc. It’s very hard to “dip in and dip out”.

Long EM equities outperformance is increasingly becoming sell-side bank research and top Wall Street “consensus view” trade/asset allocation investment recommendation for 2021.

Private clients and seasoned Investors, however, should recall the old market adage: “just because it is ‘consensus’ does not necessarily make it wrong”.

As the pandemic- and vaccine-supported global recovery unfolds, many banks remain in the Base case scenario and are leaning towards a faster global recovery in mid-2021, which is expected to be friendly to risk assets led by emerging markets equities and commodity markets.

From a technical analysis point of view and in my personal opinion: MSCI Emerging Markets is the best looking chart in the world right now.

According to Mark Mobius, the veteran EM investor who earned the moniker: “Father of emerging markets.

“Emerging markets today are best exemplified by two words: Young and Growth.”

The emerging-market countries’ population have an average age in their 20s, while developed countries have populace in their 40s. Thus, the growth of emerging markets has been faster.

The additional inputs of the latest technology are adding an impetus to growth in emerging market countries.

And, many emerging market countries have learned valuable lessons prior to crisis periods that have helped them navigate the current Coronavirus pandemic; South Korea is an example of both scenarios.

The new reality in emerging markets is characterised by increased institutional resilience, improved economic diversification, and the emergence of world-leading emerging market companies. In many cases, these EM companies are leapfrogging developed market peers through new business models, often facilitated by superior infrastructure and intellectual property.

South Korea stands out as illustrative of the aforementioned factors, and also as an example in terms of its resilience in handling the COVID-19 pandemic.

Asia’s 4th largest economy entered the Coronavirus crisis having had a negligible fiscal deficit of 0.3% last year – a fraction of the level in most developed western markets.

Historically, the basic rule in EM investing has been: “Global media’s love is a bad sign for any economy and its indifference is a good one.”

Russia has been a prime example of this adage. Russia, as an investment market, tends to be overlooked and under-owned by several global investors despite strong fundamentals and the rise of Russian retail investors as a key driver of future equity market returns.

2021 marks the 30th anniversary of the collapse of the Soviet Union, and could be a poignant backdrop for Russian politics and local equity markets as commodities can enter a post-pandemic bull market.

According to Vladimir Potapov – the CEO of VTB Capital Investments, Russia’s largest wealth and investment manager and part of Russia’s second-largest bank, VTB – the estimates on Russian equities offer over 100% upside from current levels over the next three years.

He highlights that investors get paid to wait for the rerating with a 7% dividend yield.

Commodity-rich emerging markets like Russia are the best hedge against global inflation expectations rising.

Bringing into focus the age-old adage: “Fortune favours the brave and the prepared mind.”