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Emerging markets can be an afterthought when it comes to portfolio selection, especially in the past year as the U.S. equity market has blasted through new highs and trade tensions have brought worries to countries such as China and South Korea, hurting those markets.

That said, analysts believe 2020 will be a turning point for EM, especially in performance. But that optimism comes with some caution.

The first of three reasons for optimism, Peter Gillespie, managing director at Lazard Asset Management, told ThinkAdvisor, is “we are expecting a temporary truce in the trade war between the [United States] and China,” he said. “That has probably been the biggest overhang in the emerging markets.”

He believes the tension between the two countries will ease and they will work out some kind of so-called “skinny deal,” which would be helpful for emerging markets over the next 12 months or so.

With an ease in trade tensions, “we’re expecting earnings to rebound in emerging markets next year,” especially after being relatively flat in 2019. These returns, he says, could be in the mid-teens.

On a more secular note, “we do think emerging markets are increasingly dominated by more global, more innovative, more entrepreneurial firms,” which bodes well, he says, for a multi-year EM outlook, especially in China and South Korea.

In fact, outside investment in China also should grow in the next year, as limits on foreign ownership of fund management companies are to be removed by April 1, 2020. A Cerulli Associates survey found a 4.2% growth in assets under management in China the first nine months of 2019, bringing it to $1.9 trillion. In addition, a pilot program by its regulator was launched to test the investment advisory business on mutual funds, allowing fees of no more than 5% of client AUM. Although Chinese investors are new to fee-based models, it will help spur the industry beyond the sales-driven model, Cerulli states.

JPMorgan’s 2020 Investment Outlook echoes much of what Gillespie highlighted, stating “the most important issue remains the evolution of trade policy: No further trade shocks should permit EM Asian economies to stabilize, and overall EM inflation and interest to remain low.”

It notes that China’s growth should stabilize to just below 6% due to “cyclical and structural factors, monetary and fiscal easing over the past 18 months.” But the JPMorgan report also points out that China’s sustainable growth will be “anchored by the consumer: the rise of China’s middle class should continue to fuel demand for consumer goods and services.”

They also see a pickup in growth in Brazil and Mexico, which will allow “the region to expand more strongly in 2020.”

Where the Bargains Are

Gillespie says EM is “really taking leadership in the world,” especially in technology. He points out that in countries like China and South Korea, most places don’t take cash or credit anymore and expect to be paid via mobile phone app. “It can be difficult to pay for things as simple as a cup of coffee [if you don’t have the app],” he notes, adding that this adoption of digital payments is certainly making those countries leaders in the area as well as in online sports gaming.

He sees growth in several types of business and product platforms, “different ecosystems,” like an Apple vs. Galaxy mobile phone, “but going forward, most likely those players will be coming out of the emerging markets.”

JPMorgan highlights “pockets of opportunity,” adding that “with the global economy stabilizing and trade escalation less likely, EM equity performance should be positive in absolute terms as these confidence variables add a bit to returns.” It sees double-digit growth, but also says investor confidence is necessary in the short term due to currency swings versus the dollar, and thus emerging market investors must focus on the long term.

“Many U.S. investors remain extremely underweight EM equities, increasing the importance of considering adding to this asset class as a way of boosting returns,” JPMorgan notes.

Gillespie concurs. “The emerging market has changed as an asset class over the last 10, 15 years or so,” he says. “It has moved from an index that was sort of dominated more by the materials/commodity space and [now] is more into technology and innovation. I argue for a greater exposure to emerging markets and people applications, and maybe viewing them as more of a secular holding as opposed to an opportunist or tactical one.”

— Check out All Eyes on China-U.S. Trade War Outcome in 2020 on ThinkAdvisor.