19 Jun 2023
It’s no secret that 2022 was a bruising year for equities. The war in Ukraine, surging inflation, and China’s COVID lockdowns, left emerging markets as no exception. With what was a stronger final quarter and a solid start to 2023, one might ask what and where the prospects may be found for emerging markets in the months and years ahead?
At abrdn, we’re focusing on four key issues. First, the likelihood of a US recession, its implications for interest rates, and the dollar. Second, China’s economic rebound. Third, a potentially exciting decade for emerging markets in general. And lastly, fundamentals and valuations.
Let’s take the US first. A recession here would boost the case for greater diversification in global portfolios – a positive for emerging markets. The economic downturn would entail lower inflation and, as a result, lower US interest rates. Lower, or even flat, interest rates would spell the end of the long rise in the US dollar and allow other currencies to recover. The US dollar is probably the biggest factor in capital flows into emerging markets and the returns that those markets produce. So, if we do see a recession, which we expect towards the end of 2023, it should create a relatively benign environment for emerging markets.
A US recession would also entail weaker corporate profits in the US. That is likely to contrast to the earnings situation elsewhere. As the Chinese recovery takes hold, earnings in the developing world are likely to be on the up, with consequences for share-price multiples, which are currently rather depressed. So, there is certainly scope for further rotation from the US to the rest of the world – and especially to emerging markets.
In China, the government has switched from a strict zero-COVID policy to one of herd immunity: accepting that the pandemic is now endemic. We’re expecting positive economic developments not just in China but in emerging markets as a whole. In the past few years, one of the big factors in the weakness of emerging markets has been the lack of Chinese tourists. So that’s one area where we expect a striking turnaround now that China has opened its borders in both directions.
Another benefit of China’s reopening is the boost to its domestic consumption. The China consumption story is huge for emerging markets, underpinned as it is by record-high saving rates. The spending of some of those savings should have a major economic impact, both at home and abroad.
Something we’ll be watching carefully is the property sector. A great deal of Chinese wealth is tied up in property, therefore one of the challenges for the authorities is to achieve at least a stabilisation of property prices. That’s because property prices will be crucial in determining how much Chinese consumers are willing to spend.
The Chinese authorities have made it much easier for property companies to raise money and are looking to encourage more construction and property sales. This must be balanced with the government’s other main aim of ensuring the availability of sufficient affordable housing.
Overall, we expect the property market to stabilise rather than return to its earlier excesses. This should be beneficial for domestically oriented Chinese companies, especially those in the e-commerce sector.
Why are we so excited about the next decade in emerging markets? Well, since the global financial crisis of 2008, we’ve seen less and less capital expenditure. Instead, investments have poured into research & development, and intangibles. Now, however, we expect that to change. And that has important implications for the relative performance of emerging markets and developed markets.
We think that the main driver of this renewed capex will be green initiatives with greater focus and effort to be spent on the rebuilding of grid systems and power-production applications. And this represents a sizeable opportunity for many emerging market companies.
There will also be significant capex involved in the de-risking of supply chains. One effect of heightened Sino-US tensions is that supply chains are shifting. Some of that involves ‘onshoring’: Mexico is doing well as the US looks closer to home for its needs. We also expect other emerging market countries, like India and Indonesia, to benefit from these long-term trends.
All of this leads to why we think emerging markets will do much better in 2023 than in 2022. Looking at fundamentals and valuations, we expect quality to make a comeback with operating conditions likely to remain difficult, not least because of high interest rates and the looming US recession. In this environment, higher-quality companies should be better placed to come through in good shape.
Meanwhile, valuations in emerging markets still look cheap. Emerging markets are still trading at a significant discount to developed markets. Given the positive trends in currencies, COVID recovery and capex, we see this as a compelling reason to continue to invest.
Author: Devan Kaloo, Global Head of Private Markets
The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.