24 January, 2024. Outwardly emerging markets equity returns appear to have disappointed again in 2023, with the benchmark EM index up only 10% in an otherwise strong year for global equity markets. But a deeper analysis reveals much to be positive about. For example, 19 out of 24 emerging markets registered positive US$ returns in 2023. Of the top 8 markets (88% of the universe), 7 registered positive returns, with 6 of the 7 seeing strongly positive double digit returns. Eastern European equities were up 47%, Latin American equities by 33% and Asian equities by 8%. So why the seemingly weak headline performance of EM? That is entirely due to a rather large bear in the China shop driving returns in that market for the year down -11%. EM ex-China performed robustly up +20% for the year. If a bull was ever to chase the bear out of the China shop, returns could be very strong for the asset class.
A disparate range of countries, at different points in their economic cycles and with widely differing policy environments, emerging markets are an early-cycle asset class and tend to perform strongly as the world recovers from a recession. Rates in emerging markets have been higher for longer, meaning there are more levers to pull as and when we find ourselves back in a period of monetary loosening. Furthermore, interest rates have normalised between developed and emerging markets, meaning developed markets have lost their low cost of capital tailwind, with the playing field now looking a lot more even. We are close to peak negativity on China, be it politically, economically or corporately.
Finally, one of the big things that drives our asset class is the US dollar. If rates are close to peaking in the US, that removes a big tailwind to the US dollar. If we think the dollar has peaked, that is a positive environment for emerging markets. This makes for an exciting stock-picking opportunity looking forward in our view. In particular, with economic growth likely to be slow and/or slowing in 2024, we believe markets are likely to reward companies that can “win” in this environment and punish “losers” ferociously.
Therefore, we can see the potential for returns to be driven much more by the companies that have been most resilient or have adapted best to this turbulence. However, there are also likely to be many companies which have yet to wake up to the changes the volatile macro situation has wrought in their businesses. In other words, we are hopeful this will be a year where the market focuses on winning and losing companies, creating a much friendlier environment for stockpickers.
The great thing about the Chinese market is how deep and diverse it is. There are 4,000 listed companies across a wide range of different industries and those industries have sub-cycles in them. We are excited by the energy transition, where China is a leading player, the shift to consumer premiumisation, and travel, where currently, flights from the US to China are still only at 10% capacity relative to pre-Covid volumes.
Looking elsewhere, and this is true of the asset class more broadly, if one country or industry is troubled, there is normally another country or industry doing very well indeed, and that is the case now. While China is obviously going through a tough patch, but we don’t believe it is structurally challenged.
Outside of China, Latin America has had extremely elevated interest rates for some time, and inflation appears under control, meaning when interest rates come down again, that will be positive for those markets. The Middle East is experiencing a capex boom as countries invest the oil windfall into transitioning their economies into a post-oil environment. Additionally, places like Mexico, Thailand, Malaysia and Indonesia are benefiting from supply chains relocating out of China.
If we look industry-wide, technology has been a tough place to be over the last year because we have been working through an inventory glut post-Covid. Given the boom in AI, companies must invest in bigger, better, faster data in their IT systems to keep up. We think there is a great longer-term resource story.
Therefore, we look at a world that we believe is rich in opportunity for our investment process, where the emerging market opportunity has not been so out of favour for 20+ years. This could be a rich period for both market alpha and beta in the emerging world. It is also worth noting that 2024 will profile one of the great positives in our world today – elections involving 4 billion people globally, many of them in emerging markets. We are convinced that Churchill was right, and that democracy is the worst way to run the world apart from all the other ways….thus elections are both a wonderful thing to behold but also a rich source of risk for an investor. Consequently, careful management of risk will also be essential in 2024; that 2024 may bring surprises should not be surprising given the lessons of this decade so far.