Emerging Markets (EM) lagged in 2023 for the third successive year due to restrictive interest rates, weaker than expected earnings growth, structural challenges in China and rising geopolitical uncertainty. However, 2024 has been more positive, with EM and Asia Pacific moving up the ranks of relative return, hinting at a brighter future for the asset class.
Source: J.P. Morgan Asset Management, 24th October 2024
Support from easing global interest rates
Central banks in developed markets are moving towards looser monetary policies and lower interest rates, which is expected to ease pressure on EM currencies and therefore release constraints on EM central banks. After implementing aggressive rate hikes in 2021-2022, EM inflation is mostly in check, allowing these banks to cut rates decisively, especially with real rates at the upper end of their historical ranges.
This sets a favourable backdrop for both EM local debt, where investors can pick-up attractive yields, but also EM equities, as lower interest rates are likely to spark an increase in domestic spending, helping to drive a pick-up in GDP growth.
Source: J.P. Morgan Asset Management, 2024
Domestic consumption: the new growth engine for Emerging Markets
Historically, exports have been a key driver of EM growth, but this is changing. Incremental improvements in GDP per capita and targeted policies to boost domestic investment and reduce dependency on international trade, are combining to drive the rise of the domestic consumer. This shift is most visible in China and India, and is now emerging across Latin America, the Middle East and Eastern Europe.
This is being accelerated by global trends like onshoring and de-globalisation, fostering greater economic independence and resilience against global market fluctuations. This secular shift will take time to unfold, but it promises differentiated returns for investors and enhances portfolio diversification.
Winds of change
Markets often respond to momentum, and EMs are beginning to see positive surprises in economic data, despite subdued global growth forecasts. This optimism is expected to grow, especially with China’s recent slew of supportive policies aimed to stabilise its property market and reinvigorate consumer and business confidence. Time will tell as to the extent of its success, but the breadth of coordinated measures shows an encouraging sign of purpose and intent.
Source: LSEG and Schroders Strategic Research Unit, 4th September 2024
Alpha opportunities
An important consideration for investors in EM, especially those using a passive approach, is understanding the composition of the index. China, with a 27.8% weighting in the MSCI EM index, has a significant bearing on total returns for the asset class. However, the index also includes India, Taiwan and South Korea at 19.5%, 17.6% and 10.4%, meaning EM returns aren’t solely reliant on China’s performance.
For active managers, this offers a promising landscape to pursue alpha. Given the less efficient nature of EMs, this is something our investment team is leaning into.
Capturing alpha in EMs requires patience and discipline, but the potential to tap into attractive risk-adjusted returns over the long term is clear. Since Q1 2023, EM ex-China returns have shown steady growth, but this shifted materially following the recent stimulative policy announcements in China leading to a rapid catch-up. For the nimble and dynamic active manager, these relative movements represent compelling alpha generating opportunities within the EM landscape.
Source: Alpine Macro
Attractive valuations, low correlations and light ownership levels
EM currently offers investors both value and growth. It may not have the Magnificent 7, but it is forecast to earn 15% EPS growth in 2025, similar to the US, yet trading on almost half the PE multiple. This gap is likely to narrow over time, and with easing monetary and fiscal policies in EM, the room for upside surprise in consensus earnings forecasts looks increasingly favourable.
The low correlation between EM and Developed Market equities is an additional attraction, something we value highly within our multi asset portfolio construction.
At a time when investors are underweight, we believe this represents an attractive combination for investors with a long-term view and who are tolerant of volatility.
Source: J.P Morgan Asset Management
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.
