Emerging markets outlook

What happened in 2023?

The positive outlook for Emerging Market (EM) investments took a hit in 2023. Initially, investors were excited about the prospect of a stronger Chinese economy, a weaker US dollar, and lower expected interest rates. Unfortunately, these expectations didn’t quite pan out, leading to lower returns. As US yields rose and the dollar strengthened, China’s recovery also fell short of what was hoped for. This disappointment caused investors to lose interest in emerging market assets, affecting both stocks and bonds to varying extents by the end of 2023. However, does that pose opportunity for investment in 2024?

What do we classify as emerging markets?

Thinking of emerging markets as one homogeneous group could be construed as a mistake due to each country in the EM universe having their own unique characteristics. While there are shared risks like sensitivity to geopolitical events and overall risk tolerance, it’s crucial for investors to acknowledge the differences. Factors such as whether a country is an energy exporter or importer, and whether its economy is based on manufacturing or services, can create significant distinctions. These differences highlight the diversity within the group.

Illustrated in the graph below is the performance of different emerging market indices as defined by MSCI.  Chinese stocks make up about 30% of the benchmark emerging market stock index, but only 4.7% of the debt index in hard currency and 10% of the local currency market. The rationale for investing in Chinese stocks or bonds can be quite different to that of the rest of the emerging market group. [1]

MSCI Emerging Market Indices 2022 & 2023

Source: FactSet, MSCI. [2]

What do we think about China?

China has experienced a year full of ups and downs. While the economy has achieved around 5% real GDP growth, which is respectable, it’s slower than the pre-COVID period. The property sector faced challenges, leading to concerns about financial stability. Despite the official target being met with circa 5% real growth, nominal GDP growth is lower at about 4.1%, highlighting ongoing deflationary issues. [3]

Throughout the year, there were hopes in the markets for significant policy easing from Beijing, but it did not materialise. MSCI China ended 2023 with double-digit declines (-29%), the domestic A-shares market was down 3%, and the RMB was 4% weaker against the USD. This contrasted with positive gains in other countries.

Efforts such as ending the ‘Zero Covid’ policy and relaxing real estate restrictions did not bring the expected results. The annual Central Economic Work Conference (CEWC) presented another opportunity for a policy shift, but the message from policymakers indicates a continuation of the current course. The focus is likely to remain on transitioning away from the property sector while supporting financial stability, especially for local governments. Weaknesses in the economy, such as low demand and poor policy execution were acknowledged. Fiscal policy is expected to play a more prominent role next year in ensuring reasonable economic growth, taking over from monetary policy.

As the housing crisis becomes less prominent in the coming years, we anticipate an improvement in the overall magnitude of China’s economic growth. Specific economic reforms tailored to stimulate growth through innovation in consumption, services, technology, and higher-value-add manufacturing could contribute to this change.

Chinese Equities vs. Global Developed Equities Forward Price/Earnings

Looking ahead, there may be some potential for Chinese equities. The current valuations of Chinese equities appear to be cheap when compared to the last decade, and in relation to the MSCI World Index, which represents stocks in developed markets.

However, there is reason to be cautious when choosing to invest today. MSCI China fell again the first month of 2024, posting a negative 10% return. Our ongoing focus remains on closely monitoring economic indicators in China, and researching opportunities for exposure through indirect investments, such as in industrial metals and European equities that are heavily tied to the health of the Chinese economy.

Has there been a shift to India?

India is heading into a phase of self-sustained growth, driven by previous reforms that are creating a positive cycle of expansion. This momentum could potentially lead to annual nominal gross domestic product (GDP) growth of up to 10% in the next decade. General elections, due this month, are forecast to see the incumbent Bharatiya Janata Party (BJP) and Prime Minister Narendra Modi secure victory. Our research indicates focus on rising demand for financial services, infrastructure investment, consumerism, and the green transition in India are connected to three main pillars of growth.

Firstly, there’s a significant boost in growth from broad-based infrastructure and manufacturing investment, complementing already strong consumption-driven growth. Services exports are expanding to include global centres specialising in areas like accounting, marketing, and human resources.

Secondly, there’s a notable shift from unorganised to organised economic activities. Previous reforms are bringing more labour into the organised economy and reducing the appeal of cash-based transactions.

Lastly, there’s increased political and economic stability, marked by low inflation and a consistent reduction in the current account and fiscal deficit. The government recognises its role in kickstarting a new industrialisation process, capitalising on opportunities from initiatives like “Make In India,” the diversification of global supply chains, and the green transition.

Over the last two years, the market, as reflected by the Nifty 50 Index, has shown positive performance. However, it hasn’t kept pace with the cumulative earnings growth of 31%. This discrepancy has led to lower valuations, opening fresh investment possibilities. Looking ahead to 2024, there could be a potential revaluation of the market, especially if foreign investors recognise that India’s growth is more of a long-term structural trend rather than a short-term cyclical pattern.

India Earning Per Share throughout Economic Cycles

CAGR = Compound Annual Growth Rate

Source: Bloomberg; Nifty 50 EPS estimates. The NIFTY 50 is a benchmark Indian stock market index that represents the weighted average of 50 of the largest Indian companies listed on the National Stock Exchange. Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or a guarantee of future results. [5]

A flurry of Indian investors is expected to join the stock market through the expansion of systematic investment plans and increased involvement from insurers and pension providers. This could potentially result in billions of dollars flowing into the market. Additionally, a rise in foreign investor allocation has the potential to bring in more capital, supporting a potential revaluation of the market.

As of now, the MSCI India Index’s price-to-earnings ratio (P/E) is trading at about one standard deviation above its 10-year average, based on the consensus earnings forecasts for 2024. Looking forward, the forecasted 17% growth in earnings for 2024 supports the current P/E ratio. While some other markets may have a lower price-to-earnings ratio, we believe they lack the long-term growth potential that India offers.

MSCI India vs MSCI EM Price/Earnings

Source: FactSet. The MSCI India Index is designed to measure the performance of the large- and mid-cap segments of the Indian market. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging markets countries. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses, or sales charges. Past performance is not an indicator or a guarantee of future results. [6]

What about Latin America?

Latin American economies, influenced by both the United States and China in terms of trade and investment, encounter distinct challenges and opportunities from the wider EM group. The high-interest rates in the United States present a significant obstacle for Latin American economies. The Federal Reserve’s monetary policy directly affects capital flows, exchange rates, and inflation, making it tough for Latin American countries to lower their own interest rates to boost domestic growth.

The increasing significance of China in Latin America brings about positive impacts, such as strengthening exports, fostering economic diversification, attracting investment, and promoting overall economic growth. However, the recent slowdown in the Chinese economy poses significant risks. Latin American countries heavily reliant on commodity exports may face reduced demand and lower prices, potentially leading to economic instability. Moreover, if the region becomes overly dependent on Chinese investments, it could experience market volatility and financial pressures.

The challenge for policymakers is to maximise the benefits from the global economy while working to minimise the impact of external shocks. Key strategies include diversifying trade partners and bolstering domestic economic fundamentals, such as productivity and innovation. Latin American countries might reassess their international alliances and partnerships based on the changing dynamics between the US and Chinese economies. This could result in diplomatic shifts and geopolitical implications in the region. To conclude, Latin America does show promise in 2024, however, most of our research focus will be on watching for changes in political regimes in the regions.

How will global elections play a role?

The year 2024 is gearing up to be a particularly eventful one on the global electoral stage, impacting both emerging and developed markets. With elections in countries contributing to over a third of emerging market gross domestic product, these votes carry significant consequences for geopolitics, potential shifts in global supply chains, and the long-term economic reform outlook in specific markets.

Map of Countries involved in Major Elections in 2024

Source: Bloomberg [7]

As the world witnesses an ongoing economic divide between US- and China-led blocs, elections in Taiwan early in the year and in the United States later in 2024 could further widen this gap. In Taiwan, a change in leadership might bring a more volatile relationship with China, but recent polls indicate a potential easing of tensions if the opposition wins. Meanwhile, the US election presents uncertainties, with former President Trump facing legal challenges, and President Biden’s age raising concerns. The outcome could influence the nation’s stance on international relations, particularly with China, either unilaterally under Trump or more multilaterally under Biden.

Indonesia and India also face crucial elections that could shape their long-term structural reforms. In Indonesia, continuity is expected as both candidates pledge to pursue business-friendly reforms. In India, Prime Minister Modi seeks a third term, and a victory could pave the way for sustained economic growth through gradual reforms and capitalisation on global supply chain strategies.

However, in some countries, elections may signal a departure from fiscal responsibility, raising public debt risks. South Africa, for instance, faces potential fiscal challenges if the ruling party fails to secure a majority. Argentina, under President Milei, is actively addressing its economic crisis through measures such as devaluing the peso and implementing spending cuts.

Overall, the upcoming elections in 2024 have the potential to reshape political landscapes, impact international relationships, and influence economic trajectories in various parts of the world.

A thought on artificial intelligence

The AI revolution in emerging markets presents an exciting chance for leapfrogging advancements. Unlike developed market countries, EM countries have the advantage of not being burdened by legacy infrastructure, allowing them to progress more rapidly. For instance, businesses in EMs can design state-of-the-art data centre architecture without the constraints of reconfiguring existing systems. Furthermore, there’s a shift expected in data centres, transitioning from merely providing storage to offering substantial computing power. This shift creates significant opportunities for businesses operating in this sector.

An integral component of this revolution is Generative AI, expected to usher in transformative advancements across diverse industries, especially in secondary and tertiary sectors. Its applications extend from automating everyday tasks to groundbreaking innovations in healthcare and supply chain optimisation, offering significant advantages for companies in emerging markets. The potential for EM companies to actively embrace and capitalise on these opportunities has the capacity to propel growth in their share prices.

Final thoughts

While emerging markets may experience fluctuations due to overall market volatility, we see potential opportunities within this expansive investment landscape, particularly in the equity space. When it comes to equities, we continue to focus on an active approach that emphasises areas of the market showing structural growth. In essence, emerging market equities provide exposure to countries exhibiting robust economic growth and lower leverage when compared to developed market economies. This exposure can contribute diversification benefits when integrated into broader investment portfolios.

We believe it’s essential to treat different parts of emerging markets uniquely, considering their difference in sector focus and their geographical advantages such as climate and availability of resource. As an example, in 2023, we made the decision to invest in Fiera Oaks’ Emerging Markets fund, which specifically focuses on frontier markets. A frontier market refers to the market economy of a developing country that is smaller, riskier, and may be less liquid, making it distinct from broadly classified emerging market economies. These markets are often in the earlier stages of development, and examples include Greece, Saudi Arabia, and Vietnam. [8]

The fund has consistently shown strong performance, highlighting Saltus Asset Management’s commitment to building portfolios with a diversified actively managed approach.

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