All EMs In Latin America Rose, Colombia Being The Top Performer In The Region
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Emerging Market Insights
Three things we’re thinking about today
We are optimistic that emerging markets, in particular Chinese equities, can post positive returns in 2023. Drivers of our optimism include:
- China dismantles its zero-COVID policies: The removal of almost all COVID-19 restrictions in China is resulting in a wave of infections, with up to 80% of people in urban areas contracting the virus. As the wave subsides, economic activity is expected to normalize. Durable goods and financial services are likely beneficiaries of a resumption in normal patterns of human interaction and trade. A recovery in outward-bound tourism is expected to benefit economies in Asia, which prior to 2020 were the prime beneficiaries of the large number of Chinese tourists.
- Peak in US interest rates: Consensus expectations point to two further increases in the US federal funds rate in 2023. While the timing of eventual rate cuts remains uncertain, the peak in rate hikes is the first step on this journey. The US dollar has already reacted to expectations of a peak in interest rates in 2023, trending lower in recent months. US dollar weakness should benefit emerging market fund flows, reversing the outflows of recent years, which in turn is supportive of emerging market equities
- Acceleration in renewable energy investments: The “new normal” of elevated fossil fuel prices is likely to incentivize emerging markets to accelerate decarbonization efforts in order to reduce energy costs and meet their Paris Climate accord targets. This will create potential opportunities for emerging market investors. The battery industry—for both electric vehicles and battery electric storage systems—as well as the solar industry, stand out. China and South Korea are at the forefront of new battery technologies, commanding 83% global market share between January-October 2022. India is also investing heavily in the solar industry as it seeks to become self- sufficient in photovoltaic panel production.
Outlook
As we head further into 2023, we find many reasons to be constructive about emerging markets (EMs). Markets such as Chile and Indonesia have started to pause interest-rate hikes or scale back the magnitude of their rate hikes. We expect a policy pivot to revive consumption and spur economic growth as inflation slows. In addition, after a slowdown in earnings in 2022, there is a prospect for a recovery in earnings growth in 2023. We view China as a leader with a near-15% estimated growth, based on consensus expectations.However, we are of the view that earnings may continue to still be relatively weaker in China in the near term, with a recovery timed toward the end of 2023 instead. Nonetheless, a pickup in earnings revisions in EMs would signify better times ahead for earnings and in turn, equities.
Although a weakening global outlook appears to be on the horizon, economies with a greater focus on domestic demand are better placed to weather a challenging environment. These markets include EM countries such as India, Brazil and Indonesia.
India has attracted investors looking to diversify their manufacturing bases from China. Similarly, the Middle East is experiencing an upturn in consumption, due to a spillover from high energy prices.
China’s recent policy changes and low equity valuations have created opportunities locally as well as in Asia more broadly, as China is the largest driver of economic activity in the region. China’s reopening could benefit EMs outside of Asia as well. As mobility in China bounces back to pre-pandemic levels, its demand for oil will also likely increase. This benefits several non- Asian EMs which supply crude oil to China, including Saudi Arabia, Kuwait and Colombia. While the risks of 2022 have abated slightly, we remain watchful for developments that could change our overall EM outlook, including China’s relationship with Taiwan and the United States.
As the investment environment evolves, an important feature that we seek in EMs is resilience, in terms of both economies and companies. A particular area of focus for us is the sustainability of corporate earnings, whether in the face of COVID-19, policy changes, technology disruption or other challenges. We see companies with structural growth drivers aligned with digitalization, decarbonization and premiumization emerging as long-term winners.
Emerging markets key trends and developments
The combination of a weaker US dollar, receding inflation and China’s pivot away from zero-COVID spurred investor confidence in the latter months of 2022. The release of third-quarter corporate earnings results and confidence in the growth outlook for several EM economies also buoyed returns. However, political uncertainties capped gains—the Chinese equity market’s selloff after the 20th National Congress and a lack of policy clarity in the wake of Brazil’s presidential elections are two examples. Nonetheless, global equities still rose over the fourth quarter of 2022 (4Q22), with both EMs and developed markets performing on par. The MSCI Emerging Markets Index rose by 9.8%, while the MSCI World Index advanced by 9.9%, both in US dollars in 4Q22.
The most important moves in emerging markets in the fourth quarter of 2022
Emerging Asian stocks finished the quarter higher. Stocks in China contributed to regional gains after policymakers dismantled their zero-COVID policies. The long-embattled property sector also received a boost from support measures, with leading Chinese institutions extending loans to the sector. India’s equity market also advanced amid softening inflation and lower oil prices. Indonesia’s market, the sole laggard within emerging Asian economies, fell as its central bank raised its policy rate again.5 The policy rate was most recently raised by 25 basis points (bps)—a smaller magnitude than past hikes—reaffirming that inflation was easing.
Latin American EM equities also swung higher in 4Q22. All EMs in Latin America rose during the quarter, with Colombia being the top performer in the region. Market-watchers welcomed Colombia’s aim to take advantage of higher energy prices by targeting a 15% increase in crude oil output. Heavyweight Brazil’s equity market also advanced, albeit at a more moderate 2.5% for the quarter, as consumer prices rose less than expected.
EMs in the Europe, Middle East and Africa (EMEA) region saw mixed results, although the region as a whole managed to eke out gains. Saudi Arabia’s market declined, capping gains for the region, as soft oil prices and a weaker US dollar weighed on sentiment—the Saudi riyal is pegged to the US dollar. Turkish equities led gains as investors increased their equity allocation to hedge against inflation and a low-yield environment.
