Nov 27, 2023
No. After a poor 2022, our expectation would have been for the asset class to recover more than it did in 2023. There are two principal reasons for this: continued geopolitical turmoil being the first and second much deeper and quicker monetary tightening than we envisioned at the start of the year.
Three issues give us reason to be very cautious in the near term. First, the war in Ukraine and the conflict in the Middle East could escalate at any moment, and that is a concern. Second, the geopolitical risks around China could continue and, as we head into an election year in the US in 2024, we will no doubt hear and see a lot more US posturing against China. This is just the beginning of a long road about how China and the US settle down into a new, and hopefully constructive, status quo. The third is monetary tightening. When you endure tightening this aggressive, typically it ends with a bang, and not a whimper. So, as we move into 2024 the world will be increasingly thinking about a recession and that is going to be a tough transition for markets.
There is plenty of room for optimism on a 1- or 2-year view, given that the building blocks for a turnaround are beginning to fall into place. To reiterate, I believe there is a high chance of a recession in 2024, but markets will look ahead and start to think about who is well placed to ride the recovery wave back up.
Emerging market equities 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.
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 as well. 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. 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. 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 have to invest in bigger, better, faster data in their IT systems to keep up. We think there is a great longer-term resource story.
The single aspect most market participants misunderstand about emerging markets is the sheer cyclicality of the asset class. When we look at cycles, some investment styles work better at certain parts of the cycle than others. So, quality will work very well in a bear market; value and momentum will work much better in a bull market, etc. Given that cyclicality, we think a blended style approach such as 4Factor has the potential to provide that consistency of performance through what is a very cyclical asset class.
General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company.