Summary
The pandemic has given digitalization in emerging markets a permanent uplift.We view resilient technology demand as a multiyear tailwind for EMs.We see technology playing a critical role in another secular trend—the pursuit of net-zero carbon emissions in EMs.
By Chetan Sehgal, CFA, Senior Managing Director, Director of Portfolio Management, Franklin Templeton Emerging Markets Equity & Andrew Ness, ASIP, Portfolio Manager, Franklin Templeton Emerging Markets Equity
Beyond the pandemic, there are long-term technology trends shaping the future in emerging markets, according to Franklin Templeton Emerging Markets Equity’s Chetan Sehgal and Andrew Ness. They say resilient technology demand is a multiyear tailwind for emerging markets.
Key Takeaways
The pandemic has given digitalization in emerging markets (EMs) a permanent uplift. The consumer internet industry has so far led the way in digital transformation, though we have also begun to see industrial internet applications take off as manufacturers tap innovation to raise productivity.As a whole, internet businesses have become all pervasive and still have significant scope for growth across EMs. As the number of internet companies multiplies, so will competition. We are mindful of this and favor companies that can sustain their competitive advantages.We see technology playing a critical role in another secular trend—decarbonization. Many carbon-intensive companies anticipate higher carbon costs and are actively employing technology to cut their emissions.
The discovery of the COVID-19 Omicron variant has generated economic uncertainty and market volatility. At the time of writing, it remains too early to draw conclusions about the pandemic’s path ahead, and we are monitoring the situation closely. What we know is this: much of the world is learning to live with COVID-19 as vaccination rates climb and new treatments arrive. Even as new variants delay the return of pre-pandemic normalcy, the worst market fears should be behind us. We expect pandemic worries to recede gradually and unevenly. This should help bring the structural growth drivers in EMs back into investors’ view.
Tech-Tonic Shift
We view resilient technology demand as a multiyear tailwind for EMs. The pandemic has given digitalization a permanent uplift, even as economies continue to normalize. The consumer internet industry has so far led the way in digital transformation, though we have also begun to see industrial internet applications take off as manufacturers tap innovation to raise productivity. A growing appetite for industrial internet solutions points to more technology spending ahead.
The overall internet landscape across EMs remains dynamic and diverse. China has served as a massive laboratory, pioneering business models in e-commerce, online payment, and other services that other markets have subsequently adopted and adapted to succeed in their own right. In South Korea, for example, a leading internet search company is also one of the largest e-commerce players in the country. A major Russian bank has built an online ecosystem spanning e-commerce and other digital services. Many internet businesses have also just started to list publicly in markets such as Southeast Asia and India. As a whole, internet businesses have become all pervasive and still have significant scope for growth across EMs.
As the number of internet companies multiplies, so will competition. We are mindful of this and favor companies that can sustain their competitive advantages. We are also on the lookout for the next big innovations. China, South Korea, Taiwan, and other markets with deep technology capabilities appear well-positioned to drive the next wave of breakthroughs.
Semiconductors form the backbone of technology progress and we expect demand for them to stay strong, which should benefit world-leading semiconductor companies in South Korea and Taiwan. An additional demand boost could come from longer-term developments in the metaverse. Meanwhile, sustained software needs should buoy prospects for technology services providers. Across EMs, cloud solutions are in a nascent stage of growth and we think there is room for their penetration rate to catch up with that in the Western world.
Decarbonization Drive
We see technology playing a critical role in another secular trend—the pursuit of net-zero carbon emissions in EMs. Advanced semiconductors hold the key for building better-performing hardware that consumes less power. Consumer and industrial internet applications have also helped to optimize supply chains, streamline logistics and drive other efficiencies that reduce carbon footprints.
Many carbon-intensive companies anticipate higher carbon costs and are actively employing technology to cut their emissions. For instance, a steel company in South Korea has developed artificial intelligence to monitor and optimize the operation of blast furnaces, which can pare its energy consumption. We believe there can be investment opportunities in high-emission companies that have the commitment and technological tools to decarbonize as they would be able to survive the higher carbon costs in the future.
EMs have also been accelerating their push for electrification and renewable energy. Electric vehicle (EV) adoption could quicken, which supports our optimism toward companies in the EV value chain. We are also positive on world-leading solar energy companies in EMs.
Addressing Market Concerns
We view technology and decarbonization as long-term investment themes in China, although the country’s zero-COVID-19 policy and recurring lockdowns could hamstring its near-term economic growth. Regulatory changes in China have also led to a reset in the market’s growth expectations for some of its largest internet companies. That said, we believe that their stock valuations have adequately reflected this reset.
Russia-Ukraine tensions have brought Russian equities down from recent highs fueled by commodity price strength. While geopolitical uncertainty warrants attention, market valuations in Russia look attractive to us. Elsewhere, stock valuations in Brazil have shrunk amid rising interest rates, fiscal concerns, and political uncertainty ahead of next year’s general elections. We find Brazil’s stock market undervalued. We view Brazil as a COVID-19 recovery play and its economic growth could surprise on the upside, aided by efficiencies arising from a thriving internet economy.
Inflation has dominated market concerns amid supply chain disruptions, pent-up demand, and the commodity upswing. We see the potential for supply chain bottlenecks to ease as COVID-19 restrictions gradually loosen. Demand should also normalize, which is likely to reduce support for commodity prices. Considering these factors, we don’t view inflation as a longer-term concern for EMs.
A Sustainable Story
EMs are a long-term story of evolution and progress. Amid various changes, what we ultimately seek are companies with sustainable earnings power, trading at valuations we find attractive. A key feature that we look for is management teams with the flexibility to adapt to shifting business conditions. Companies with strong and enduring competitive advantages also stand out to us. We believe that our investment approach is a durable strategy for capturing opportunities in EMs regardless of market cycles.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets, and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors, or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. Investments in fast-growing industries like the technology sector (which historically has been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
There is no assurance any estimate, forecast, or projection will be realized.
Source: seekingalpha.com
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