Our Opinion: 2023
Time to buy emerging markets
After a decade of disappointing returns, could we be due a rally in emerging markets?
Emerging markets (EMs) are on course for another disappointing year. The MSCI EM index lost a fifth in 2022 in US Dollar terms. It regained 4.9% in the first six months of this year, but that is still well short of the 15% average rise across developed markets in the same period. On a price/earnings (p/e) ratio of 13.6 (compared with 20.3 across developed markets) EMs are undoubtedly cheap.
EMs’ discount to developed-world stocks has not been this large since they suffered a series of currency crises in the 1990s. Buying EM stocks worked out very well the last time they were this cheap. The new millennium ushered in a bull market fuelled by China’s ferocious appetite for buying commodities. Yet the boom ended after the global financial crisis and since then the story has been of unremitting under-performance.
Worse for investors seeking diversification, EMs have followed more mature markets, mirroring, and exaggerating, the direction of the US stock market on the way up, and the way down. EMs typically beat developed markets in up-year because easy money pushes investors to seek returns in riskier corners of the world. Yet that pattern has failed to hold this year, with EMs lagging ebullient developed markets. That is partly because US interest rates are still rising, which allows US money managers to earn attractive returns at home. It is also because of China’s lacklustre recovery: the country’s equities account for 30% of the MSCI EM index and China is an important source of demand for other emerging economies.
The China factor has been overstated, however. Investors bet on a post-Covid shopping boom, but Chinese consumption has ‘low import intensity’ (many goods are made in China, after all). Except for a few tourism-dependent economies like Thailand, most emerging economies are encountering relatively limited headwinds from China’s difficulties.
Indeed, most EMs have shown remarkable resilience during this global slowdown. In the 1980s, there were never fewer than 25 emerging nations in default. Today, there are just five. Inflation is running at comparable rates to those in developed economies, the product of central banks that take inflation seriously. The old notion that ‘emerging’ is another word for ‘reckless’ no longer applies. With inflation coming under control, EM central banks should be able to start cutting rates sooner than developed ones. That will boost stocks. US interest rates are peaking, which should act as a catalyst for emerging market equities.
There is no guarantee that EMs will soar over the next year but, in the long term, they are where the growth is.
31st July 2023
