China’s economic reopening is proceeding swiftly, despite the spike in COVID-19 cases in early January
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Exhibit 1: Emerging Market Country Performance
As of January 31, 2023
Sources: FactSet, MSCI. Note: Bubbles size reflect relative market capitalization, ex China, which is resized to 50% of actual market capitalization. Performance as represented by individual/respective MCSI country indexes. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. For illustrative purposes only and not reflective of the performance or portfolio composition of any Franklin Templeton fund.
Three things we’re thinking about today
- China’s reopening and impact on energy prices. China’s economic reopening is proceeding swiftly, despite the spike in COVID-19 cases in early January. Investor attention has recently switched to the reopening’s impact on energy prices. In contrast to Europe, China is experiencing a bitterly cold winter, with average temperatures 15ºF below average for the month of January.[1] This is increasing demand for natural gas, the majority of which China imports from overseas. Liquid natural gas (LNG) prices in Asia and Europe have not yet reacted to the frigid weather in China, as Europe is experiencing temperatures on average 15ºF above average over the same period.[2]
- However, if this were to change, LNG prices could rise, reigniting global inflation concerns and limiting China’s room for fiscal maneuvering given gas subsidies provided to households. Markets pivot toward growth. January witnessed a dramatic shift in the performance of growth stocks, with the MSCI Emerging Markets Growth Index posting double-digit returns.[3] Value stocks witnessed positive performance but lagged behind. This is a reversal of the 2022 performance trend, wherein value stocks performed better than growth stocks as rising interest rates undermined the outlook for the latter. Looking ahead, the likelihood of a continuation of this January’s trend will likely be dependent on the direction of interest rates and the US dollar, among other factors.
- Emerging markets (EM) earnings outlook. Consensus expectations are for a recovery in emerging market earnings in 2023, following a sharp decline last year.[4] China’s reopening and economic recovery is expected to drive earnings, particularly in the financials and consumer discretionary sectors. High interest rates typically benefit banks, and a recovery in consumer technology business prospects looks likely to us, including e-commerce.
Exhibit 2: Earnings Per Share (EPS) and Earnings Revisions As of January 31, 2023
Outlook
The prospect of weaker external demand has led policymakers in EMs turn to domestic demand, in particular consumption, to shore up economic growth. For example, South Korea plans to offer large tax breaks to semiconductor and other technology companies investing within the country. The country is also planning to make investing in the local stock market easier for foreign investors and is providing subsidies for citizens to cope with increasing prices. Thailand has also approved a budget to boost tourism in the country, one of its biggest growth drivers.
The long-term structural tailwind of EM consumption growth via expansion of the middle class and premiumization of buying patterns is now more significant than ever, in our view. The Chinese consumer opportunity is under the spotlight following the country’s economic reopening. Some US$2.6 trillion in Chinese bank deposits were amassed in 2022[5]—and middle-class households are looking to draw down these saving to spend on experiences, products and services. This is driving the premiumization trend opportunity at the heart of the EM consumption story we see. Other opportunities that look to boost EM growth besides Chinese consumption abound. For example, a surge in initial public offerings in the Middle East should help drive consumption via a trickle-down wealth effect. We believe these uncorrelated drivers of returns in EM economies present an investment opportunity which our team’s deep experience, local expertise and a bottom-up investment approach are poised to uncover.
While this is a time of uncertainty, we continue to stress the importance of taking a long-term view and undertaking due diligence in making investment decisions. With over 30 years of experience in EMs, we are no strangers to market uncertainties and are experienced in investing through highly volatile periods, which we believe has helped us remain calm in the current market environment. We recognize that this period will pass, with history having shown us that markets should eventually stabilize and recover.
Emerging markets key trends and developments
Global equities began the year on a strong footing and nudged higher in January, with EM equities outpacing their developed market counterparts. Cooling inflation and growth in the US economy spurred sentiment, raising hopes that the economy may avoid a recession. Within EMs, analysts have raised 2023 earnings estimates for Asian companies given slowing inflationary pressures and China’s reopening.[6]
For the month of January, the MSCI Emerging Markets Index rose by 7.9%, while the MSCI World Index advanced by 7.1%, both in US dollars.[7]
The most important moves in EMs in January 2023
Emerging Asian stocks finished the month higher, holding onto gains from the previous quarter. Once again, China was a leader in the region, buoyed by the government’s support for the economy to spur domestic demand and revive the property sector. A possible peak in COVID-19 infections, signs of normalization of China and the reopening of the China-Hong Kong border also boosted sentiment. Conversely, Indian stocks were under pressure from continued selling and higher oil prices.
Latin American EM equities also swung higher in January, with all countries showing gains. Regional heavyweights Mexico and Brazil started the year on higher ground. Brazil reported a sharp drop in inflation at the end of 2022 due to fiscal measures and monetary policy tightening. Mexico saw economic activity rebound in 2022 as the tourism sector experienced a revival. Exports from the automotive sector also contributed to Mexican economic growth. EMs in Europe, Middle East and Africa also advanced as a whole but saw more moderate gains than Latin American and Asian EMs. Saudi Arabian shares ended higher amid a recovery in oil prices, and South African equities benefited from relatively cheap valuations and a slowing inflation rate. Conversely, Turkish stocks tumbled and ended a prior rally as investors shifted their risk appetite and took profits in a market which outperformed in 2022.
Index Definitions
- The MSCI EM Latin America Index captures large- and mid-cap representation across five emerging markets (EM) countries in Latin America.
- The MSCI Emerging Markets EMEA Index captures large- and mid-cap representation across 11 emerging markets (EM) countries in Europe, the Middle East and Africa (EMEA).
- The MSCI EM Asia ex Japan Index captures large- and mid-cap representation across two of three developed markets (DM) countries (excluding Japan) and eight emerging markets (EM) countries.
- The MSCI Arabian Markets Index captures large- and mid-cap representation across 11 Arab markets countries. With 88 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
- The MSCI China Index captures large- and mid-cap representation across China.
Regional outlook
Three-month period ended December 31, 2022
|
Market |
Conviction |
Investment Thesis | ||
|
Latin America | ||||
|
Brazil |
|
The economy has been recovering which is driving earnings growth, but inflation dampened sentiment as interest rates remain elevated. With inflation now trending down, sentiment is improving and the market is beginning to look for the time when easing will begin. Sustainability of long-term growth will be helped by additional economic reforms, privatizations and concessions. President-elect Lula’s economic policies are a risk for the market, in our view.. | ||
|
Mexico |
|
Soft confidence indicators are consistent with the expectation that the data will show the economy decelerated in 2H 2022. The decline in consumer confidence is broad based and with households turning visibly more pessimistic about the outlook for the economy. The decline of business confidence in the manufacturing sector is also broad-based and skewed towards expectations over current conditions. | ||
|
Peru |
|
Political uncertainty has created a negative environment that, if reinforced, could end up affecting investment and consumption decisions in 2023. | ||
|
Emerging Europe | ||||
|
Czech Republic |
|
Economic sentiment continues to deteriorate, reflecting the restraining impact of monetary tightening and external headwinds. Pricing intentions continue to remain high across industries and hiring demand has remained strong, indicating monetary policy will likely continue to be tightened. Gross domestic product (GDP) growth of 1.7% is expected in 2023, with the downside scenario related to a protracted disruption in energy flows from Russia resulting in a 2.5% decline in GDP.[8] | ||
|
Hungary |
|
Economic sentiment remains weak as economic growth is under pressure due to weakness in the industrial sector and the tightening of monetary policy. GDP is expected to increase 2% in 2023 if there are no energy shortages, with a downside scenario of a 4.5% decline in GDP if there is a protracted disruption in energy flows from Russia. The hoped-for resolution of the Hungarian-EU dispute, relating to rule-of-law reforms, did not materialize by the end of 2022, although Hungary did lift its opposition to sending EU funds to Ukraine. Future progress is likely to be determined by the extent of the domestic economic slowdown, which could put pressure on President Orban to settle the dispute. | ||
|
Poland |
|
Private consumption should support GDP growth in 2023, and the economy will likely grow by 4.5%. Growth is 2023 is forecast to be 2.4%. A worst-case scenario based on a protracted disruption to energy flows from Russia could result in a 2% drop in GDP growth in 2023.[9] | ||
|
| ||||
|
Middle East | ||||
|
Kuwait |
|
Strong fiscal position, but delay in reform and issuance of debt law leaves the sustainability of the longer-term path in question. Rich valuations and a weak growth outlook lead us to a negative market view, although a potential surprise on the debt and mortgage laws can be short-term positives for the market. | ||
|
Qatar |
|
Activity related to the FIFA 2022 World Cup and LNG production expansion present a case for a growth and earnings uptick for the next 3-4 years. Qatar offers stability due to its high sovereign reserves and a low oil budget breakeven point. | ||
|
Saudi Arabia |
|
The outlook is improving but remains anchored to normalization of economic activity, oil prices and PIF/private sector spending. Forex reserves (c. $US450 billion) and PIF assets ($US360 billion) lends comfort. | ||
|
UAE |
|
High surpluses set the stage for the government to push its growth agenda. Recovery in tourism and real estate sales, along with economic reforms, are expected to keep growth steady. A privatization program in Dubai and Abu Dhabi is helpful in increasing capital market depth. | ||
|
Emerging Asia | ||||
|
China |
|
China reached an inflection point with the easing of access to credit for the real estate sector in October. This was followed by a significant reset in US-China relations at the G20 meeting in Bali. The final catalyst is the dismantling of China’s zero-COVID policies. | ||
|
India |
|
We believe the market is expected to move sideways over the next 6-12 months as roll forward of earnings is likely to be offset by further valuation correction and some cut to consensus estimates. Long-term themes such as under-penetration, formalization and stable government remain intact, however. Global commodity prices will be a key to monitor. | ||
|
Indonesia |
|
Elevated commodity prices provide an economic tailwind, with resilient domestic demand growth trends lending support. | ||
|
South Korea |
|
US recession risk and weakness in the semiconductor sector are weighing on sentiment. Political tension with North Korea remains elevated. | ||
|
Taiwan |
|
Cross-strait geopolitical risks are a known factor for the market. We keep the status-quo assumption unchanged, despite the Russia/Ukraine war, which has raised concerns of the potential relationship deterioration between China and Taiwan. The corporate outlook has turned more negative amid weakness in the semiconductor sector. The increasing tensions between United States and China is an overhang for the corporate sector. | ||
|
Thailand |
|
Overall, the outlook appears stable. Domestic consumption could experience some tailwinds as the economy reopens, though there are some concerns on inflation amid geopolitical uncertainties. We anticipate a gradual tourism recovery as China dismantles its zero-COVID policy. Pre COVID-19, arrivals from China accounted for 25% of total tourist arrivals.[10] | ||
|
Africa | ||||
|
Egypt |
|
High inflation and further currency depreciation necessitates higher interest rates. An IMF loan package of $US3 billion over 46 months was reached in October. We understand that this deal might be contingent upon the government agreeing to increase the private sector’s involvement. | ||
|
Kenya |
|
While we believe valuations are cheap, the outlook is starting to turn negative given the foreign exchange crisis, inflation higher, election risk and poor long-term rains. | ||
|
Nigeria |
|
The risk of further currency weakness remains high, in our view, and the weak political and macro environment creates a poor backdrop for stocks, while subsidy costs offset persistently higher oil prices. | ||
|
South Africa |
|
The near-term outlook is getting questioned amid global risks such as inflation, interest-rate hikes and Chinese demand. A long-term recovery is still dependent on the ability of the government to execute and commit to other reforms. | ||
Source: Emerging Markets Insights | Franklin Templeton
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Source: Climateengine.com ↑
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Ibid. ↑
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Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. ↑
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Source: Bloomberg, as of January 31, 2023. There is no assurance any estimate, forecast or projection will be realized. ↑
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Source: People’s Bank of China ↑
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Source: Reuters, January 10, 2023. ↑
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Source: MSCI. The MSCI World Index captures large- and mid-cap representation across 23 developed markets countries. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging markets countries. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Important data provider notices and terms available at www.franklintempletondatasources.com ↑
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Source: Bloomberg, November 30, 2022. There is no assurance that any estimate, forecast or projection will be realized. ↑
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Ibid. ↑
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Source: Bank of Thailand. ↑
