Making the case for emerging market stocks

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Q4 2021 Putnam Emerging Markets Equity Fund Q&A

• We remain bullish on emerging market equities despite economic headwinds ahead.
• Semiconductor and financial technology companies are providing new and viable investment opportunities.
• Risks include rising global interest rates, inflation, and slowing growth in China.

How was the investment environment for the fourth quarter?

Overall, for the period, emerging market stocks fell. Market volatility was driven by concerns about rising inflation, an uneven global economic recovery, and the Omicron variant of Covid-19. Other key global equity market indexes also seesawed during the quarter, with some managing to hold on to gains. The S&P 500 Index, a broad measure of U.S. stocks, rose 11.03%. The MSCI World Index [ND], a broad measure of equity securities from developed countries, gained 7.77% during the period.

For emerging market investors, a strong U.S. dollar, higher interest rates, and the Federal Reserve’s plans to accelerate the taper of its stimulus spending in a bid to combat rising inflation created some risks. Central banks in some developing countries, including Brazil, Chile, South Africa, and Russia, have started to raise interest rates. In addition, China — the world’s second-largest economy and a key trading partner — is starting to see slower economic activity. Despite some uncertainties during the year, our outlook remains bullish for emerging markets.

For the fourth quarter, the Putnam Emerging Markets Equity Fund fell 1.44% compared with a decline of 1.31% for its benchmark, the MSCI Emerging Markets Index [ND].

What is attractive about emerging market stocks at this time?

Innovation is driving growth across emerging market countries. We believe many of the leading companies of the next 20 years may originate in emerging markets, supported in part by their leadership positions in STEM [science, technology, engineering, and mathematics] education, innovation in technology applications, and a growing tech-savvy population. The dominance in several areas, including semiconductors and fintech are creating some exciting investment opportunities, in our view.

As more and more items are rebuilt and redefined as a “smart” tool, semiconductors have become more integral to our daily lives. Asia has an outsized exposure to some of the leading companies globally in this sector. Two compa-nies, one based in Taiwan and one in South Korea, currently dominate the global semiconductor landscape. These two firms have over 135,000 employees and spend over $65 billion annually on capital expenditures to expand their technological advantages.

Many emerging market companies have leapfrogged from credit cards to mobile payments. Mobile payments are becoming the standard from Brazil to India. Internet connectivity is also an important driver in this space. Additionally, growth in areas such as online banking and alternative lending platforms is expanding banking access among growing populations in many developing countries, including Latin America.

As the fund begins a new year, what is your outlook?

As we enter 2022, we remain attuned to macroeconomic issues such as rising inflation, higher interest rates, and mobility restrictions due to the spread of the Omicron variant. However, we also see many opportunities to find companies that are navigating these headwinds.

Emerging market company valuations remain attractive. Stocks in the United States trade at a price-to-earnings [PE] ratio of 23 compared with 12 in emerging markets. In terms of profits, many emerging market companies have had higher earnings growth than companies in the United States this past year. Yet, developing market equities have underperformed. Going forward, we believe earnings-per-share [EPS] growth for companies in developing markets will be driven by innovation and faster economic growth.

The setup for international equity outperformance is compelling, in our view, given discounted valuations and faster EPS growth. We believe emerging market stocks can hold their multiples — estimated EPS growth of 15% and a dividend yield of 2% — to potentially create double-digit returns. We continue to believe that rapid innovation in Asia will transform the equity landscape in the 2020s and 2030s.