Emerging markets are winning some plaudits among investment managers. What lies behind their increasing popularity?
- Emerging markets appear to be further through their economic cycles, with inflation dropping
- China is driving growth in the broader Asia region and for other emerging markets
- Emerging markets are also benefiting from the weakness in the Dollar
A number of major investment managers are backing emerging markets to outpace developed markets in the months ahead. BlackRock and Fidelity have both stated their preference for emerging markets assets in recent weeks. After nearly a decade in the doldrums, what explains their new allure?
While emerging markets haven’t been immune to the problems facing developed markets, in many cases they appear to be further through their economic cycle. In Brazil, for example, CPI inflation fell to 4.18% in April of 2023, the lowest since October 2020, having nudged 12% in early 2022. This is a reflection of the speed with which emerging market central banks ramped up interest rates and suggests they are likely to be in a position to ease policy sooner than in the US, UK or Europe.
Emerging markets such as China haven’t seen much of an inflation problem at all. Consumer prices rose just 0.1% in April, the slowest rate in almost two years. This gives the Chinese central bank considerable flexibility should they need it to get the economy restarted.
For Fidelity, the potential strength of China is a key factor in its emerging market overweight position, both in equities and bonds. Its multi-asset team says the country’s emergence from zero Covid is driving growth not just for China, but for the broader Asian region and for other emerging markets. BlackRock also highlights the resurgence of China as a reason to support emerging markets.
The final factor is the weaker Dollar. The Financial Times highlights fund flow data from EPFR Global, showing that investors are rotating from emerging market hard currency bonds (mostly denominated in US Dollars) to local currency debt. Since the start of the year, investors have withdrawn a net $2.65bn from hard currency bond funds, and added $5.23bn to local currency bond funds as they have fallen out of love with the Dollar. With an imminent recession in the US, the Dollar may weaken further.
Valuations for emerging markets remain vastly cheaper than for US equities. The MSCI EM index trades on just 11.8x forward earnings, compared to 16.5x for the MSCI World. Dividend yields are notably higher, at 3.3% versus 2.1%. Price to book ratios are also significantly lower.
Global emerging markets have lagged most other major markets for the year to date, with the weakness of Chinese markets dragging down overall returns. However, it is difficult to see how developed markets can continue to outpace them as their economies weaken. Investors are increasingly starting to pay attention to the value on offer.
