Emerging market strengths beyond a slowing China

‘Under-owned, underestimated and unloved’ is how investment trust managers described emerging markets when speaking to the Association of Investment Companies at the start of 2024, which reflects both their pessimism and optimism as a new year begins.

A quick comparison shines a light on the problem. Global equities ended last year more than 22%* higher. By contrast, Emerging Markets (EM) rose just under 10% *.

In developed market equities, many regional indices recovered most of the ground lost in 2022, but for emerging markets much of 2022’s losses are yet to be recovered. Emerging Asia and Emerging EMEA (Emerging Europe, Middle East and Africa) remained subdued (despite a resilient India, one of the best performing emerging markets in 2023), while Latin America performed better.

“Since peaking in early 2021, Asian and emerging market equity markets have struggled amidst a liquidity tightening cycle and a crescendo of negativity surrounding China,” admits Charles Bond, co-manager of the Invesco Global Emerging Markets fund.

It’s well-understood that China’s post-Covid recovery has disappointed. Its fragile property market has fed weak consumer confidence, despite abundant household savings and solid balance sheets.

The potential for a turnaround in Emerging Markets

There are a range of factors that could prompt a turnaround in emerging markets in 2024. Upcoming EM elections have the potential to shake things up, including one recently held in Taiwan, plus those in Pakistan and Indonesia, India, Mexico and South Africa.

There are also EM bargains galore. “Valuations for regional indices trade below long-term historic averages, in terms of price-to-book, and are at a significant discount to developed markets, particularly the US,” Charles points out.

Additionally, Asian and EM economies enjoy relatively solid fundamentals, suggesting greater monetary policy flexibility should growth headwinds start to build. They should be in a position to cut interest rates sooner than many developed markets.

In China, for example, coordinated monetary and fiscal easing is already underway - and with greater urgency - to boost confidence and support growth. The Central Bank of the People's Republic of China announced a 0.5% cut in bank reserve requirement ratios as part of its continued gradual easing of policy**.

China casts a huge shadow over EM, but the asset class is big, varied, and, according to Invesco’s Charles Bond, on track to “provide interesting investment opportunities”, with the continued divergence in performance and valuations between different countries and sectors within the emerging world.

“The expected emerging markets earnings recovery in 2024 makes for an interesting set up for the asset class, compared to 2023 and compared to expectations for developed markets, particularly given the valuation discount and current low levels of EM ownership within global portfolios,” Charles says.

Alternative exposure to China
India remains the best multi-year structural EM growth story, and the expectation is for Modi to replicate his electoral success at the state level in December in national elections this year, and for economic strength to continue.

Those looking to gain exposure to the region may consider Goldman Sachs India Equity Portfolio or UTI India Dynamic Equity fund, for high-conviction exposure in a portfolio. However, if you want to spread your bets a bit further, FSSA Global Emerging Markets Focus and GQG Partners Emerging Markets Equity have 28%*** and 29%**** respectively in India, while still offering exposure to China, Mexico and Taiwan, to name a few.

Alternatively, Mark Hammond, manager of the Guinness Asian Equity Income fund, likes Latin America. “It saw very strong performance last year, and has continued to benefit from a proactive approach to monetary policy”, he says. By raising rates early in the cycle, central banks in the region have now found themselves in a position to start lowering rates.

With only ten funds making up the IA Latin America sector, options for concentrated exposure are limited. However, investors can gain some exposure to the region through funds such as FP Carmignac Emerging Markets which has over 20%*** of the portfolio in the region.

Emerging market currencies also showed remarkable resilience in 2023, Mark points out, and if we do begin to see rate cuts this year in developed markets, he expects that to ease pressures on EM currencies further.

Emerging markets are home to many best-in-class companies globally – growth stocks at value prices – driven by innovation, consumption, and commodity resource advantage. At one time just buying China was enough, but now managers need to cast a wider EM net.

*Source: MSCI index factsheet, 29 December 2023
**Source: CNBC, 24 January 2024
***Source: fund factsheet, 31 December 2023
****Source: fund factsheet, 30 November 2023

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.