Why the emerging markets run has legs Why the emerging markets run has legs http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\china-ancient-architecture-small.jpg April 28 2023 February 22 2023

Why the EM run has legs

It starts with China. Other forces also are at work.

Published February 22 2023
My Content

No doubt emerging markets face challenges. Neither the dollar’s rebound since the end of January nor the increasing likelihood of a higher for longer Fed terminal rate are EM friendly. Geopolitical tensions over a balloon and a gruesome, grinding war in Ukraine represent headwinds, too. But let’s not get carried away. While the MSCI EM Index has fallen 3.5% so far in February, dropping its year-to-date return to just above 4%, that’s on the heels of a nearly 22% rally over the prior three months. After an even stronger move, up 50%+ off last fall’s lows, stocks in China also have given ground. None of this is surprising. Profit-taking is typical after big bounces. From our vantage point, this year’s EM outlook remains promising and it starts with China. Consider:

  • Chinese society has returned to normal China’s already back to pre-Covid levels based on some metrics of activity. A 100-city gauge of vehicular traffic is running at 105% of 2019 levels and an 18-city subway traffic gauge is at 106%. During January’s 7-day Spring Festival/Chinese New Year, total travel hit 308 million, up 23% year-over-year, just shy of 2019 levels. Movie box office revenues totaled almost $1 billion, the second-highest grossing week ever for the festival. After 2022’s omicron lockdowns, everyone wants out of their Covid caves. Many of my friends and family there are traveling. My mother has gone on two trips since Spring Festival, and she’s 78! More common statistics also suggest the world’s largest export market and second-largest economy is recovering much faster than many expected. Its services PMI shot out of the gate in January and its manufacturing PMI expanded for the first time in four months,
  • Growth is priority No. 1 Over the last few years, the mindset of China’s leaders was not on growth but on growth-inhibiting Common Prosperity initiatives, including new regulations on technology, education, entertainment, etc. On top of that, it also locked down much of the country last year due to omicron. The combination proved counterproductive for the economy, which suffered its slowest growth in 50 years in 2022 save for 2020’s global pandemic shutdown. Now, the government’s priorities have changed. It has eliminated Covid restrictions, eased regulations and is supporting loan growth and easier money. It still has in its pocket direct payments to consumers and the potential use of quantitative easing, measures it never used even as other countries did, if it feels consumers are being too reticent to spend. In other words, the government seems certain to keep on releasing more and more policies to boost the economy if the previous ones don’t prove effective. The steps it already has taken, and the recognition that it may do more, have prompted widespread upward revisions to China GDP forecasts, with the International Monetary Fund (IMF) pushing its projection for real growth to 5.2% this year from 3% in 2022. Citigroup has gone even higher, to 5.7%.
  • The Fed is closer to an end than a beginning Despite its recent rally, the dollar is more likely to decline than rise over the course of the year as the Fed’s tightening cycle eventually ends. Even if Chair Powell et al don’t pause as early as markets had been expecting, we’re not going to see another 450 basis points of increases this year. Perhaps 50, even 75. I leave that to our money market and Fed experts. The point is, with Fed hawks nearing a landing, it’s hard to see the dollar gaining more strength. That’s a positive for emerging markets, many of which took their rate medicine earlier than the U.S. and are now positioned rather conservatively, with ample currency reserves and trade surpluses. Not everyone, but a majority. A weakening dollar typically drives EM currency strength and better EM equity performance.

To be sure, geopolitical issues are a black swan. It took one wayward balloon to put U.S.-China relations back in a deep freeze, just at a time there were signs of a thaw. Maybe there still can be some sort of détente, though tensions over reports that China may be considering supplying Russia with military supplies and that House Speaker Kevin McCarthy plans to visit Taiwan this year are certain to keep relations on edge. Still, as China’s economy perks up, so should growth in its Association of Southeast Asian (ASEAN) neighbors, as well as Europe, regions with which it has strong trade ties. I’m visiting South Korea, Taiwan and China over the next few weeks in hopes of seeing evidence first-hand. India is doing better, too, and the IMF has raised growth forecasts for Mexico and Brazil. Even parts of Eastern Europe are expected to improve, despite the pall of Russia’s war on Ukraine. The bottom line: while there will be challenges, the EM story potentially could be one of the better ones in a year where investors still have many doubts.

Tags International/Global . Equity .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

Purchasing Managers’ Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

Stocks are subject to risks and fluctuate in value.

The MSCI Emerging Markets Index was created by Morgan Stanley Capital International (MSCI) to measure equity market performance in global emerging markets.

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