Our Opinion: 2022
The maturing emerging markets
2022 has been a difficult year for Emerging Markets. Headwinds included a strong US dollar, global inflation, heightened geopolitical tensions, and growth weakness in China triggered by both COVID-related restrictions and a property market slowdown. This may have been enough to tip these countries into crisis this year. But, so far, most have held up better than predicted.
That is testament to a vast shift in the global economy over the past decade. No longer just a source of cheap labour and cheap commodities for the rest of the World, emerging markets (EMs) are key sources of demand in their own right today. Their own consumption has almost tripled over the past 12 years and now amounts to 47% of the global figure. The currencies of Brazil and Mexico have risen even as the yen, pound and euro have slid against the dollar.
Bigger currency reserves and deeper local financial markets have boosted EM resilience in recent years. A strong dollar is also less of a problem than in the past because EMs are increasingly able to borrow in their own currencies. For example, in the mid-2000s 83% of Chilean debt was owed in a foreign currency, but that had fallen to 32% by last year, leaving the country far less vulnerable.
The MSCI EM index is down 27% so far this year, compared with a 22% fall in the equivalent developed-market index. That reflects a gloomy outlook across emerging Asia. China’s market is troubled, while South Korea’s benchmark Kospi index is down 38% this year and Taiwan’s Taiex has slumped by 40% after adjusting for currency depreciation.
Still, EM equities could be nearing a bottom. On about 10.5 times next year’s earnings, emerging markets are cheaper than the post-2010 average of 14. But that discount partly reflects steep downgrades in Chinese assets.
Better opportunities are to be found in Brazil, India and Indonesia. Indonesia’s reserves of nickel leave it well-positioned for the energy transition, and India could be poised to take China’s place as the linchpin of the EM complex thanks to its strong demographics and ongoing wave of digitisation.
Brazilian equities have room to outperform their EM peers in 2023. After years of disappointing returns, Brazilian stocks reawakened in 2022, thanks to a rotation away from growth-oriented sectors (such as tech and telecoms) into value-oriented ones (like energy and financials), along with higher commodity prices. The October presidential election was initially positively received by the market, but sentiment turned negative after President-elect Luiz Inácio Lula da Silva (or Lula) signaled his intention to amend the spending-cap law, provoking worries over Brazil’s fiscal sustainability.
It is currently less likely for Lula to implement drastic fiscal policies, due to sufficient checks and balances in Congress and other domestic political constraints. But uncertainty is likely to stay high until the Congressional outcome of Lula’s expenditure plan and candidates of the new government’s economic team are known.
Volatility will persist before a market turnaround but 2023 may be the year when some emerging markets mature.
29th November 2022
