Emerging markets have been a tough spot over the past 12 months, even by the standards of 2022. However, there are better signs for many emerging markets in the year ahead.
- The average emerging market fund dipped 12.2% over the year with the MSCI Emerging Markets index faring worse
- Dollar has notably weakened since September last year, which removes a major drag for emerging markets
- China may also move from a negative to a positive in the year ahead as it reopens
There has been little love for emerging markets in 2022. While there have been pockets of strength – India stands out – most investors won’t have regretted bypassing the asset class altogether. However, the stars are aligning for a better year in 2023, as the global economic cycle turns, China revives and the mighty Dollar weakens. Should investors be taking another look?
The average emerging market fund dipped 12.2% over the year. The MSCI Emerging Markets index fared worse, falling over 20%, thanks to its high weighting in China and, in particular, Chinese internet stocks. Among active funds, those with an income mandate, or that specifically excluded China, fared best. M&G Global Emerging Markets, for example, and Invesco Emerging Markets ex China were both up over the year having had little direct exposure to Chinese equities or the Internet sector. The strong performance of India kept many emerging markets funds afloat.
There are compelling reasons to re-examine the sector in the year ahead. The Dollar has notably weakened since September last year, which removes a major drag for emerging markets. The strong dollar has raised the cost of dollar-denominated debt and imports for emerging markets, which has weakened economic performance. At the same time, the higher yields available on US government bonds had drained fund flows from elsewhere, pushing emerging market currencies lower.
China may also move from a negative to a positive in the year ahead. The government’s clamp down on the powerful internet sector, along with the Zero-Covid policy and trouble in the property sector, had created a perfect storm. However, policymakers have shown little appetite for further curbs on entrepreneurship and have been taking a slower approach to addressing the indebtedness of some property developers. The abrupt reversal of the zero Covid policy has surprised even seasoned China-watchers.
While India now looks more expensive, it still appears to have a long pathway of growth ahead. Its economy has only been lightly touched by inflation and Modi’s reform agenda remains in tact. Many other emerging markets are only just reopening, bringing potential for an economic bounceback, and may also be closer to a turn in their interest rate cycle.
Perhaps most importantly, emerging markets look cheap. The forward P/E of the MSCI Emerging markets index is just 11.3x. That compares to 15x for the MSCI World. Morgan Stanley Wealth Management’s chief investment officer said this week: “We think it may be time for investors to reassess their exposure to emerging markets.” Certainly, it could be a better year ahead for the world’s developing economies.
