Chinese EV and hybrid vehicle sales declined
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Three things we’re thinking about today
1. Rising bond yields and a stronger US dollar. After falling to a low of 3.4% in early February, US 10-year Treasury bond yields have risen sharply over the past month as investor expectations of the terminal value for US interest rates moved higher.1 This led to an increase in the US dollar trade-weighted index by 3% over the same period. Dollar strength also weighed on sentiment toward emerging market equities, which have an inverse relationship with the level of the greenback. Higher US bond yields and interest-rate expectations have a negative impact on long duration assets, including technology companies. These companies, which have a high weighting in Asian emerging market indexes, tend to see downward pressure on their share prices as interest rates rise.
2. Renewed focus on governance. Selected companies in India and Hong Kong which are perceived to have below- average corporate governance have come under attack from so called “short sellers.” Aggressive accounting practices related to debt and depreciation policies are among the factors that short sellers highlight in justification of their negative views on these companies. We believe that investing in companies with good corporate governance, which includes factors such as conservative accounting practices, engagement with all stakeholders, and timely publication of annual accounts is the best way to avoid exposure to companies that are at risk from a short-selling attack. We also acknowledge that the perfect company rarely exists.
3. Slowdown in electric vehicles (EV) sales. Chinese EV and hybrid vehicle sales declined 6.3% in January.2 Chinese manufacturers have started to cut EV prices as sales soften, and in preparation for new product launches in the coming months. Balancing this negative factor is the weakness in
lithium prices, a key input material for EV batteries, which have declined almost 30% from November 2022. Lithium prices have declined on weaker-than-expected demand and rising supply. Lower lithium prices is good news for EV manufacturers, where batteries can account for 45% of the manufacturing cost.3
Outlook
The macroeconomic newsflow in the coming months may continue to cause market swings. Nevertheless, we remain focused on how the companies we invest in navigate these near- term uncertainties, as well as longer-term structural trends including digitalization and premiumization. Our investment team is focused on these trends in emerging markets (EMs), which we believe are likely to be the source of continued investment opportunities.
Over the last 10 years, we have witnessed increased EM investment opportunities due to stronger institutions, diversified growth drivers, and technological advancements. Electric vehicles (EVs), solar panels and semiconductors are a few examples. Currently, we see some of the existing trends accelerating, along with increased consumer spending power, which we believe will continue to be recurring sources of growth over the long term.
In the coming months, we believe the roll out of pro-growth policies in EMs could be a significant tailwind to domestic demand in selected markets. Across continents, local governments have introduced measures to cushion the impact of inflation and/or to spur consumption, and in turn, economic growth. In Latin America, Brazil will extend social welfare payments while Mexico and Colombia will raise the minimum wage, alongside Hungary and Poland in Europe. Some Asian governments are implementing tax cuts—the Philippines will extend lower tariff rates on eligible food items and Thailand will extend an excise tax cut on diesel. India will likely continue to prioritize capital expenditure to improve infrastructure, and has plans to venture into green tourism, where up to 50 new tourism destinations will be opened.
We believe that these policies, coupled with the presence of companies with exposure to new technologies that will drive future sustainable economic growth, present opportunities for the EM investor. EMs are home to both upstream and downstream firms in key technologies for the future including EVs, solar panels and semiconductors. Our focused investment approach enables our on-the-ground teams to identify business models and management teams that display agility and resilience in a fast- changing world.
Emerging markets key trends and developments
Both emerging and developed market equities tilted lower in February over hotter-than-expected inflation and minutes from the Federal Reserve’s most recent policy meeting that pointed to further rate hikes. Two-year US Treasury yields neared a 15-year high, further weighing on equities.
For the month, the MSCI Emerging Markets Index fell by 6.5%, while the MSCI World Index declined by 2.4%, both in US dollars.4
The most important moves in EMs in February 2023
Emerging Asian stocks finished the month lower, reversing gains from previous months. All countries in the sub-region declined.
Initial euphoria over China’s reopening moderated over softer manufacturing activity and a pickup in inflation. US-China geopolitical tensions also elevated investor caution. Another month of falling exports impacted technology-heavy markets of South Korea and Taiwan, while Indian equities slipped over a rise in the country’s annual retail inflation rate and a resultant 25 basis-point rise in its key interest rate to 6.50%.
All EMs in Latin America also ended the month down, with inflation a key theme in most countries. However, there were bright spots in several countries—Brazil’s economic activity increased 2.9% in 2022, with foreign direct investment reaching a five-year high in January. Mexico’s headline inflation for the first half of February receded slightly month-on-month, with a central bank official providing assurance that monetary tightening is reaching an end.
EMs in the Europe, Middle East and Africa (EMEA) region also declined as a whole. A rebound in oil prices benefitted the United Arab Emirates, while worries of Federal Reserve rate hikes hung on Saudi Arabian equities. South Africa, one of the largest laggards in the sub-region, suffered from up to 10 hours a day without electricity due to breakdowns at the state power utility.
The South African government has since taken on more than half of the state power utility’s debt.
