Conflict-related commodity market disruption is just the latest in a series of shocks testing policymakers and unsettling investors. Yet a familiar pattern is playing out in markets.
Grant Webster, Co-Head of EM Sovereign & FX: “Historically, EMs have borne the brunt of supply shocks, but in recent years resilience has become a more common theme. From the post-COVID energy/inflation shock to last year’s trade tariffs and now war in Iran, the initial EM sell-off has been brief and EM outperformance has ensued. At the same time, developed markets have faced rising yields and higher volatility, blurring the traditional distinction between EM and DM risk. Behind this lies relative strengthening in EM, with prudent fiscal policy, healthier current accounts and proactive central banks all boosting resilience. Investors and rating agencies are increasingly recognising these improvements, with the current EM upgrade cycle among the strongest seen in recent decades. Given this relative policy strength and higher real yields, we believe that EMs are better placed to withstand inflation headwinds.”
Looking ahead, the key question is whether renewed supply shocks could trigger another inflationary episode similar to 2022, when inflation peaked at around 8% in EM1 and 7% in DM.
Webster continued: “There will be winners and losers, but the backdrop is very different to 2022 when inflation forecasts had already risen sharply before Russia invaded Ukraine. Since February, EM inflation expectations have only increased by c.50bps and while a further rise is likely, high real rates across EM give central banks a lot more room to manoeuvre than their DM counterparts.”
That resilience is also visible at the corporate level, where many EM companies are used to operating with higher rates and inflation than their developed market peers.
Alan Siow, Co-Head of EM Corporate Debt: “Coupled with the strength of activity data we see across much of the EM universe, that means that EM economies should be better placed to deal with inflationary pressures arising from the supply shock vis-à-vis their DM counterparts.”
The market reaction to war in Iran is also informative through a more regional lens. While Middle Eastern markets initially came under pressure, the reaction proved short-lived. Credit spreads have already fallen back to pre-war levels, credit ratings have been largely unscathed and bond issuance is continuing and receiving strong investor demand.
Victoria Harling, CIO – Middle East and Co-Head of EM Corporate Debt: “The resilience we’ve seen in Middle Eastern markets reflects a macroeconomic transformation: many economies have worked hard to reduce their reliance on oil exports and that’s really paying off.”
The region is also benefiting from efforts to position itself as a strategic commercial and financial hub in an increasingly multipolar world. Drawing parallels with the City of London in the early 2000s, Harling continued: “Authorities have made it abundantly clear that the region is open for business, and the number of global companies establishing a presence there is rising. At the same time, the region’s bond markets are becoming bigger, broader and deeper.”
Alongside economic reform, the region is also undergoing rapid social and cultural change. Archie Hart, Emerging Markets Equity Portfolio Manager: “From the vibrant social scene in an increasingly multicultural Saudi Arabia to plans for the region’s first casino in the UAE, the Middle East is changing and fast. Coupled with a raft of favourable characteristics – from time zone to connectivity – this is one of the most exciting regions for investors today.”
The examples above help explain how the EM private credit opportunity set is inherently heavy-asset, low-obsolescence (HALO).
Kilic noted: “These capital-intensive, physically irreplaceable assets contrast with the asset-light, software services business models that are increasingly prevalent in the US private credit market and appear most exposed to risks from AI disruption.”
In EM equities, too, there are compelling comparisons to be made with the US around AI.
The AI boom increasingly depends on hardware. A small group of EM firms sit at the physical limits of that infrastructure; the “Secret Seven” may represent one of the most overlooked opportunities in global equities today.
“Against a backdrop of a global shortage of chips, AI-driven memory demand is creating an enduring tailwind for South Korea’s Samsung Electronics. SK hynix is another Korean firm benefiting from the memory upcycle underpinning AI infrastructure spend. Elsewhere, a number of companies are well-placed in the context of Taiwan’s AI-export complex and data centre supply chain demand. Some of these businesses trade at multiples that are just a fraction of the lofty valuations seen in the US today,” said Hart.
Meanwhile, CATL is an example of a listed Chinese company with a true global edge: its EV Qilin battery supports a 1,000 km driving range on a single charge. The pace of AI development in the physical economy in China is also accelerating rapidly, including advances in autonomous humanoid robotics, as evidenced by a robot breaking the human half-marathon record.
Hart: “There are increasing parallels with the dotcom bubble, when EM equity valuations remained relatively low while parts of the US stock market overheated. The years that followed saw strong EM outperformance after the bubble burst. Today, we see similar dynamics emerging, making this the most compelling entry point for EM equities I’ve seen in 25 years.”
From a more structural perspective, even as resilience strengthens the risk profile of EM assets, an enduring premium remains. Siow: “While the EM corporate credit universe is highly diverse and it’s vital to take a selective investment approach, the overall compensation for risk is generous. Across the EM universe, country-specific concerns often overshadow a company’s underlying fundamental strength, pushing yields above those offered by DM bonds of a similar credit quality.”
This phenomenon extends to the private market space.
“In the EM private credit world, the reason for the favourable risk/return profile is an enduring barrier to entry. The inherent complexity of these markets and the years required to build local expertise and origination networks mean competition remains limited, and the premium shows little sign of eroding,” said Kilic.
Taking a wider lens, with Hungarian 10-year government bond yields now within around 75bps of their UK equivalents, there is a strengthening case for taking a more holistic view of global investment allocations.
Jaspal Boparai, Co-Head of UK Institutional: “With supply shocks becoming the new norm, traditional asset class behaviour shifting and old EM/DM distinctions breaking down, investors must rethink how they build resilience and diversification in their portfolios while positioning themselves for a transforming world.”