The Emerging Markets Index is a benchmark index that tracks the performance of stocks from emerging market countries. The most widely followed Emerging Markets Index is the MSCI Emerging Markets Index, which covers 27 countries and over 1,400 companies. It includes stocks from countries such as China, South Korea, Taiwan, India, Brazil, Russia, and Mexico, among others.
EM index rising 20% since October. It is technically a bull market, so the question is how long can this carry on for and is it being driven purely by China opening up? Raheel Altaf, EM fund manager at Artemis IM gives us his outlook for emerging markets this year and what risks and opportunities he sees in them.
What are the reasons behind the 20% rise in the EM index?
Inflationary pressures across the globe and fears over an ensuing economic hard landing provoked declines in emerging market share prices for much of 2022. Optimism around China’s reopening, coupled with policy easing has restored some investor faith towards the end of the year. Since the end of October, emerging market stocks have rallied, led by Chinese shares.
What are your perspectives on this rise?
Periods of excess pessimism also coincide with the point of maximum financial opportunity. Until recently, China was following a different covid strategy than others around the world. This policy is now shifting creating tailwinds for Asian company earnings and economic growth more broadly. Signs are of an early-stage recovery, with valuations at fairly low levels versus history, this could continue for some time. With substantial excess savings in Asia likely to support consumption, there are likely to be good opportunities for investors ahead.
How have emerging markets performed historically?
Emerging markets have underperformed developed markets for over a decade now. Since October 2010, EM stocks have risen 23% compared to 200% for developed markets in us dollar total return terms. Despite this poor performance, the longer term suggests investors are compensated for the riskier EM asset class. From the end of 1987, they have risen 8.8.% per annum, compared to developed markets at 7.5% per annum. The 1.3% excess return seems small, but over a 35-year period, this difference creates a significant difference in wealth, as a result of compounding.
Which emerging markets have struggled in the current context?
Not all markets have benefited from the renewed enthusiasm toward emerging markets. In recent months India’s stock market has seen weakness as a result of a weaker rupee and concerns around the fallout from the allegations of fraud against the Adani Group. Weaker commodity prices have caused weakness in Brazil and Indonesia’s stock markets. The dispersion in returns at the country level highlights the importance of selection and a disciplined approach when it comes to investing in EM.
What are the major opportunities and risks facing emerging markets in the current context?
For a number of years, we have seen speculation following surging share prices, which has reduced the focus on fundamentals. This has created excessively high valuations in some parts of the market that have now started to unwind. We think this unwind has further to run and are therefore cautious about expensive companies that show signs of investor exuberance. We see less risk in companies that have been overlooked and trade on low valuations, but where there are signs of improving fundamentals.
From a macro perspective, we highlight the key risks/opportunities:
- US/China trade tensions
- Strong dollar
- China – more pro-growth policies and monetary stimulus
- Asia – benign inflation backdrop, monetary policy can support economic growth
- Global supply chains – EM economies benefit as manufacturing shifts away from China
- Inflation – EM policymakers acted early in hiking rates to curb inflationary pressures
How do they differ from developed markets? Does it represent a good diversification alternative?
In aggregate emerging countries continue to have current account surpluses, largely a result of the healthy fundamentals of Asian economies. Within China, recent positive developments in money supply and monetary policy suggest that sentiment could surprise positively. This easing contrasts with developed markets, where tightening measures are necessary to control inflation. With inflation at benign levels in China, we think the potential to support growth in the economy with policy measures remains significant.
In the longer term, younger working populations, growing middle classes, greater urbanization, and improving self-sufficiency suggest the outlook is a good one in the years ahead. We also think the slowing trend of globalization should mean that emerging markets offer more diversification benefits looking ahead.