The past decade has posed significant challenges for investors who have placed their bets on the emerging markets (EM) growth narrative. Over this period, the MSCI Emerging Markets index has yielded only about a third of the returns achieved by developed markets (73% compared to 213%). This disparity is attributable to several factors, including economic setbacks experienced by many EM economies following the 2001-2010 boom driven by China’s rapid growth and the commodities super cycle. Many of these economies faced uncompetitive currencies and a lack of reforms, particularly those reliant on commodity exports. Additionally, the strong US dollar since 2014 has impeded earnings growth for EM companies denominated in US dollars, compounded by easing commodity prices, a slowdown in China’s growth, and heightened geopolitical tensions.
The MSCI Emerging Markets index experienced a significant drop of 4.7% at the beginning of this year, marking its largest decline since January 1998. This was primarily due to investor concerns that the robust US economy would prompt the Federal Reserve to maintain peak interest rates for an extended period. However, the anticipation of loosening financial conditions globally has sparked a broader recovery, with riskier assets like EMs gaining 6.1% in the past three months alone.
The prospect of a recovery in earnings growth, resilience in the US economy, and the potential peak in US interest rates could drive continued outperformance for EMs. Nonetheless, risks remain, including numerous elections in the region this year, as well as potential economic drag from high interest rates.
Despite expectations of more rate cuts at the start of 2024, they are now anticipated to occur soon, which should benefit many EMs, especially in Latin America. As US rates decrease, the US dollar is expected to stabilise and weaken against other EM currencies. Historical data shows that EM equities typically rise by an average of 14% in the initial 12 months following the first Federal Reserve rate cut. Additionally, GDP growth in EMs is accelerating, contrasting with the slowdown in the developed world. According to the International Monetary Fund, developed economies are projected to grow by 1.7% and 1.8% in 2024 and 2025, respectively, compared to 4.2% for EMs in both years. This difference partly stems from EMs emerging from the COVID-19 pandemic later and lacking government support for consumers, resulting in a prolonged recovery for the consumer sector.
China’s underperformance has also impacted EMs, with a 40% drop in its equity market since February 2021 leading to significant valuation opportunities in the region for active managers. Consensus earnings growth for EM in 2024 and 2025 stands at 19% and 15%, respectively, compared to 11% and 13% in the United States. Valuations appear attractive, with EMs trading at a price-to-earnings multiple of 12x, compared to 18.9x for developed markets and 21.9x for the US.
Given the diverse drivers of growth in these markets, dispersion across countries and sub-regions is expected. Research from S&P Global suggests growth may moderate for countries that outperformed in 2023, such as Brazil, Mexico, and India, but remain relatively strong. In contrast, those that underperformed last year, including Colombia, Peru, Thailand, Hungary, Poland, and South Africa, are expected to see modestly faster growth this year.
Long-term demographic trends and the rise of the middle class make EMs appealing, though investors must be prepared for potential volatility. Considering China’s influence on the region is crucial, but there are now many ways to invest across the region without being tied to a single theme.
Investors seeking exposure to this asset class might consider the JPMorgan Emerging Markets Investment Trust, which holds 60-100 high-quality businesses with an average investment duration of ten years. Alternatively, the FP Carmignac Emerging Markets fund offers a high-conviction portfolio of 35-55 large and mid-cap firms. For those wanting reasonable exposure to China, the FSSA Global Emerging Markets Focus fund, managed by Rasmus Nemmoe and Naren Gorthy, currently allocates a third of its holdings to the country, including companies like Tencent, Tsingtao Brewery, and JD.com.
Conversely, those wary of China might opt for the Jupiter Asian Income fund, managed by Jason Pidcock, who avoids Chinese investments due to political concerns. Pidcock sold his last mainland China stocks in July 2022 and has maintained a low weight on China due to low expectations of corporate profitability relative to the rest of the region. His portfolio aims to yield 20% more than the respective benchmark, focusing on large companies with reliable returns, making it a defensive option.
Fidelity Emerging Markets Limited (LON:FEML) is an investment trust that aims to achieve long-term capital growth from an actively managed portfolio made up primarily of securities and financial instruments providing exposure to emerging markets companies, both listed and unlisted.
