Earlier this month, the International Monetary Fund (IMF) forecasted developed markets’ (DMs) growth to fall from approximately 2.7 percent in 2022 to 1.3 percent in 2023, with expectations of a slight rise to 1.4 per cent in 2024.
However, the difference in growth between developed and emerging markets (EMs) was expected to widen in favour of EMs for the first time in almost a decade.
EMs were riding an upwards trend, with growth increasing from 3.9 per cent in 2022 to 4 per cent this year, as well as projections of 4.2 per cent in 2024, the IMF found.
It’s evident that DM and EMs face different challenges. As Western nations including the US and Australia battled high inflation with back-to-back cash rate raises, Russia’s war in Ukraine continued to dampen investor confidence in DMs.
Moreover, central banks in EMs had begun raising their interest rates sooner than developed economies, with many now at the peak of the hiking cycle or finished entirely.
“Emerging markets’ central banks were generally ahead of the inflation curve and hiked interest rates earlier and more aggressively than developed markets,” said Eric Fine, portfolio manager of emerging markets fixed income strategy at VanEck.
“The result; emerging markets economies are in better shape than developed markets and policymakers can better manage turbulence.”
The professional even suggested that EMs were close to being a ‘safe haven asset’ in the current market environment.
Amit Goel, portfolio manager of the Fidelity Global Emerging Markets fund at Fidelity International, identified that EM asset valuations were much more reasonable at a 30 per cent trading discount. In comparison, DMs were close to their highest in the last two decades.
Arnout van Rijn, portfolio manager of sustainable multi-asset solutions at Robeco, paralleled the positive outlook on EMs.
“Emerging markets now offer greater upside as developed markets remain mired in economic problems,” he commented.
Looking back on the inflation curve
John Moorhead, head of global emerging markets at Maple-Brown Abbott, highlighted EMs had a history of living with higher inflation which meant they were able to raise rates faster than Western countries.
For example, Brazil’s central bank began increasing rates 12 months earlier than the US, now sitting with nominal rates of 13.75 per cent, while inflation peaked during May 2022 at 11.73 per per cent.
“This leaves emerging markets better equipped to lower interest rates in the face of any potential slowdown in global demand,” he told Money Management.
Fidelity’s Goel believed that by historically living through a higher inflationary environment, EMs had learned from the past.
“This time around, EM economies have been ahead of the curve in raising rates. While being a very heterogeneous region, one trend that we see is that EM economies are carrying positive real rates,” he said.
Moving into positive real rate territory was largely due to emerging markets lacking the excesses of COVID-19 lockdown stimulus that developed nations were still working off, recognised Moorhead.
Looking across the globe, Goel observed that Northern Asia had lower inflation of around 2-4 per cent whilst China was continuing to loosen its monetary policies. South and South-East Asia had 5-6 per cent levels of inflation, higher than its northern neighbours but still ‘well contained’, he described.
Constrastingly, both Latin America’s inflation and interest rates went into double digits last year. The IMF recorded that headline inflation in Mexico, Brazil and Chile decreased from its peak of 10 per cent in mid-2022 to approximately 7 per cent in March 2023.
“Because these economies are used to higher inflation and interest rates, most EM countries have the transmission mechanisms, such as higher wage growth, so they’re not faced with the standard of living crisis we’re seeing in many developed markets,” Goel continued.
After a decade of underperformance, Moorhead followed the sentiment that EMs were now rebounding into a period of recovery.
Forecasting China’s impact
Lower inflation was not the only factor underpinning the strength of EMs. The re-opening of China, following the removal of its zero-COVID policy in December, was forecast to be a major trend of 2023.
As the largest trading partner out of most emerging countries, China’s impact on other economies was largely inevitable.
Money Management spoke with Tamara Stats, iShares and index investments specialist at BlackRock Australasia, regarding the nation’s reset and how it would lead to a ‘meaningful rebound’ in economic activity.
“China’s re-opening not only benefits the domestic Chinese economy, but also boosts the broader EM region with a strong pick up in travel and consumption abroad,” she explained.
BlackRock’s portfolios were tactically underweight in DM equities and overweight in EMs, which was highly driven by China’s economic restart alongside the weakening of the US dollar.
Stats noted BlackRock had seen steady flows of $15.5 million into the iShares China Large-Cap ETF this year-to-date.
Moorhead echoed these thoughts, noting that China’s return to international tourism would support nearby emerging economies, such as Thailand.
“For the most part the impact has been on sentiment, where emerging markets saw a significant positive swing on China’s re-opening. From here, we are monitoring China consumer confidence as a lead indicator for consumption which we believe is the driver of China’s recovery,” he said.
Although neighbouring countries could benefit, Fidelity’s Goel reminded investors to stay aware of geopolitical risks and potential policy changes in the region.
Where to eye out looking forward
“Emerging markets are a disparate collection of countries, so there are many to watch for different reasons,” Moorhead stated.
Looking at the Asian region, investors were encouraged to keep a close eye on China’s consumption levels and how it would drive demand in other bordering nations.
“In India, consumption is slowing down at the margin after last year’s re-opening, but the ongoing investment into infrastructure and manufacturing is supporting the country’s rate of growth,” said Goel.
According to analysis from Federated Hermes Limited, India was forecast to increase its GDP by over $400 billion yearly, a scale that only the US and China had achieved.
Moving to Latin America, both Moorhead and Goel highlighted Mexico as an economy benefiting from nearshoring industrial capabilities in North America.
In addition, investors should pay attention to Brazil due to the potential for lowering interest rates, said Moorhead.
Saudi Arabia and Turkey were also pinpointed as growth opportunities, with both countries undergoing structural reform.
“While in the short-term, emerging markets are viewed as ‘higher beta’ and will likely be caught in any US recession or equity market sell off, the structural outlook is positive,” Moorhead observed.
Structural factors driving growth included increasing levels of consumption from younger demographics, the move to nearshoring industrial capacity and EMs being a lead supplier as the world shifts to decarbonisation.
Fidelity’s Goel affirmed that whilst EMs may be affected by the volatile environment in the short-term, the future was looking bright and that EM economies were now in a better position to absorb external shocks since strengthening external balances and foreign reserves.
“We firmly believe emerging markets are well-placed to provide strong returns over the medium to long-term,” he said.
“Overall, if you consider the fundamentals, quality of underlying assets and valuations, global emerging markets are in better shape, more resilient, and more attractively valued than in the past.”
