Emerging markets have never been homogenous, but in 2023 their fortunes diverged more than ever before. On the one hand was China, where stockmarkets slumped for a third consecutive year. On the other was India, Latin America and Taiwan, where punchy economic growth was reflected in buoyant stockmarkets.
China’s weakness had a significant impact on the aggregate performance of emerging markets. The overall MSCI Emerging Markets index dropped 2.9% in the year to 31 January, compared to a rise of 14.7% for the MSCI World. However, take out China and the result is very different. The MSCI EM ex China index rose 10.4% over the same period. India was the year’s top-performing major market, with the MSCI India rising 29.8%.
Even beyond this separation between China and the rest of emerging markets, drawing conclusions about emerging markets has become increasingly difficult. It used to be that emerging markets suffered significantly during periods when the dollar was high and US interest rates were rising, but were buoyed by rising risk appetite.
A recent IMF blog outlined how this relationship has broken down. “Major emerging markets have been more insulated from global interest rate volatility than would be expected based on historical experience, especially in Asia,” it said. It added that exchange rates, stock prices, and sovereign spreads had only fluctuated in a modest range. “More remarkably, foreign investors did not leave their bond markets.”
It attributed this resilience to improving policy frameworks, more flexible exchange rate regimes and growing confidence among domestic and international investors in local currency assets. This has enabled some countries to power ahead in spite of high US interest rates and a strong dollar.
This divergence between the performance of individual economies is reflected in the gap in emerging markets fund performance over the past three years. The best performing fund is the Invesco Emerging Markets ex China fund, which is up 51.9% over the past three years, while the weakest fund is the Morgan Stanley Developing Opportunity, which is down 44.7%. A simple explanation would be that those funds with significant weightings in China have struggled, while those who have more in India and Latin America have done well. Certainly, there is something to this. The top-performing fund had no exposure in China, instead holding South Korea, Taiwan and India, while the worst-performing fund had 35% exposure to China (source: FE Fundinfo to 9 February 2024).
However, it is not universal. The Guinness Asian Equity Income fund, for example, has around 30% in China, and just 3% in India in 2023, and yet the fund outperformed its peers and the benchmark. Geography wasn’t necessarily destiny. Some parts of the Chinese market performed well in 2023, notably energy and some of the state-owned enterprises.
The year ahead
For the year ahead, the views on China differ significantly. Charles Jillings, manager of the Utilico Emerging Markets trust, says: “We have only 10% of the fund in China – and when you consider the number of listed opportunities there, that’s not a lot.” The team continues to wrestle with the governance problems there and state interference.
However, Edmund Harriss, manager on the Guinness Asian Equity Income fund, says: “The idea that China is uninvestable doesn’t stack up in my view. We know there is growth, and we know everyone hates China, therefore valuations are depressed. When will it take off? I don’t know, but as companies build their earnings, and if prices remain way they are, they just get cheaper and cheaper.” He also sees value in Indonesia and Singapore in the year ahead, but says the valuation picture is variable.
However, there is more consensus on the pockets of opportunity – in technology, for example. South Korea and Taiwan look set to benefit from the revival of the semiconductor cycle. In Latin America, there is real growth in areas such as e-commerce. MercadoLibre, for example, is the largest e-commerce player in Latin America and in prime position to take advantage of a thriving middle class with increasingly deep pockets.
Jillings sees opportunities in areas such as the digital environment. “Penetration is well behind developed markets and there is a lot of growth to added.” Harriss says that in spite of technology’s strong performance in 2023, its valuation remains below its long-term average.
The energy transition is also important. Emerging markets need to undergo the transition themselves, and may also be important suppliers of natural resources to developed economies. Jillings says: “Brazil has a lot of wind in the North that it needs to get to the South.” The trust’s largest holding is Alupar Investimento, which manages electricity generation and transmission across Brazil. It is also benefiting resource-rich countries such as Indonesia, which has harnessed its strength in the commodities necessary for the energy transition to fuel an economic renaissance.
China plus One
Countries on the right side of the ‘China plus one’ trend – whereby global companies look to diversify manufacturing away from China – are also building economic strength. Jillings says: “We are seeing the impact of friction between the US and China. Businesses are being relocated to Vietnam for example. We’re increasingly seeing that the marginal next decision for companies such as Apple is towards Vietnam.” It is also giving Mexico a new dynamic and significant tailwind, while India is putting incentives in place to encourage companies to set up there.
Ultimately, the working out of these factors may be much more important in the near-term for emerging markets than whether the dollar rises or what happens in the US. A weaker dollar or falling rates may be a marginal advantage, but emerging markets’ growth is increasingly in their own hands.