Emerging markets and COVID-19

COVID-19 is already an international tragedy, and we hope you and those close to you are keeping safe and healthy.

There has been some relatively encouraging recent news about the spread of the coronavirus. It has slowed slightly in Europe, and Hubei province in China is beginning to return to something like normality. Yet we are growing increasingly concerned in the Asset Allocation team about the prospects for emerging markets in the face of the virus.

We believe cases and fatalities in these countries are underreported, a view reinforced by their having some of the lowest testing rates per person in the world. Unreported infections are an issue elsewhere too, of course, but the impact of the virus in emerging regions is likely to be exacerbated by several underlying factors.

First, many emerging countries unfortunately have less ability to implement social distancing or a lockdown, particularly in areas with a high population density in poor conditions and where everyday activities like work and sourcing food take place in less formal settings.

Many businesses in developed markets have been able to let employees work remotely and, despite the logistical challenges with which we will all be familiar, food has broadly been available in supermarkets. Many emerging markets lack both the infrastructure and office-based economies to facilitate large-scale working from home, and the advanced food supply and distribution networks that have just about kept shelves stocked here. People there will simply have to keep travelling for work and to buy essential goods.

Second, several emerging markets were struggling with social unrest and economic hardship even before COVID-19. Societies are generally more fragile under enforced lockdowns and in recessions, and this could lead to further protests across the emerging world. Such civil disobedience would in turn make it even more difficult to control the virus.

An Emergency

Third, medical facilities in emerging economies are also, broadly speaking, less well established than in developed markets. In addition, some emerging countries have higher levels of underlying health conditions, like South Africa where one in five adults live with HIV. Emerging regions do generally have younger populations, who have tended to fall less seriously ill with the virus, but overall these factors still paint a worrying picture for the potential death toll in emerging markets.

A final observation is purely economic: there is less fiscal room for intervention and support in emerging markets. Attempts to mimic a US-style stimulus – worth around $2 trillion, or 8% of US GDP, so far – would be met with a loss of credibility and debt downgrades. Emerging markets have already suffered tremendous capital outflows this year, dwarfing those of the global financial crisis in 2008. Many have been further hit by the fall in the oil price, the collapse of tourist activity, and deteriorating global trade as demand from developed markets has slowed.

Different countries will be able to deal with these problems in different ways. For some, unfortunately, locking down the economy would be either futile or impossible; the cure would be more painful than the disease. In these places, the harsh reality is that the death toll is likely to be both the highest and the most underreported. Others, like Russia, may have the economic headroom to tackle the virus like Europe has, should they choose to.

In the middle of this range of we are most concerned about the countries which are sufficiently developed to attempt to contain the virus, but too financially fragile to withstand the cost.

So, while we continue to believe emerging-market debt has an important role to play in strategic portfolio construction and there will undoubtedly be pockets of value within the asset class, to manage the risks set out above we have decreased our exposure to emerging-market debt in our multi-asset portfolios in favour of US credit. Moreover, we remain cautious on equities and other risk assets overall.

The months ahead look tough for emerging markets, but they have faced adversity in the past. Their long-run potential remains favourable once this crisis has eventually run its course.