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Emerging market macros make valuations even more attractive

30 November 2023

Tech, energy and consumer staples all look good value to these fund managers.

By Darius McDermott,

Chelsea Financial Services

What’s the first thing that comes to mind when you think of emerging markets? I’d hazard a guess that many of you will cite the shadow of China across the wider economy.

There’s no doubt the world’s second largest economy plays a role. Chinese equities are down almost 25% from their January highs, following the end of the country’s zero-Covid tolerance policy and the reopening of its economy.

But beneath this there is also growing optimism. Emerging markets have now evolved to a point where China may still influence – but no longer dictates – the outlook for the wider economy, with some countries even taking advantage of some of its failings.

Promisingly, a combination of cheaper valuations and loose macro policy is offering opportunities for investors, who are noticing the increasing divergence between emerging markets and their developed rivals.

While the Federal Reserve, European Central Bank and Bank of England are all now singing from the same hymn sheet in that interest rates have most likely peaked, further increases cannot be ruled out, and no easing is in sight any time soon.

Emerging markets, by contrast, are already beginning to ease rates. Brazil has lowered rates by a further 0.5 percentage points and, while China made no policy change at its latest meeting, further modest cuts are in prospect there.

The monetary easing now generally underway is one reason, along with much cheaper valuations, why Rupert Thompson, chief economist at wealth manager Kingswood, believes “Asia and emerging market equities are considerably more attractive than US equities” right now.

 

Volatility and valuations – could both be a positive for emerging markets?

The past 12 months have been volatile for emerging markets. But Rasmus Nemmoe, manager of the FSSA Global Emerging Markets Focus fund, believes many companies are now pricing in little improvement in their outlook – especially in places like China – something he says is too pessimistic.

Valuations for Nemmoe’s preferred companies, he agrees, are quite attractive at present, especially when compared against the US. “We believe the current correction in share prices presents an excellent opportunity for long-term investors to accumulate leading franchises at attractive prices,” he says.

Nemmoe likes digital consumer platforms that connect millions, sometimes billions, of people, such as Tencent in China, and Mercado Libre in Latin America, which has 100 million active users of its e-commerce and digital financial services.

Emerging markets tend to have younger populations than developed rivals and, with a faster growing middle class, demographics that benefit dominant consumer staple brands, such as Tsingtao Brewery in China and Colgate-Palmolive in India, offer attractive growth opportunities to Nemmoe.

“These businesses command strong margins and pricing power. Minimal capital intensity and strong cash generation supports investment for growth as well as the potential for rising dividends,” says Nemmoe, who also favours quick service restaurants and legal monopolies, such as airports.


Tech and energy hotspots

Technology is a world-leading industry across emerging markets, and the sector includes some of JPMorgan Emerging Markets Trust’s longest-held positions, while also providing a fertile environment for new ideas.

John Citron, a manager on the trust, backs two types of technology business: “tech ‘enablers’...the building blocks and tools for technological innovation, from semiconductors to automation, and broader companies with great management teams that invest in their research and development”, he says. These latter companies are, he adds, adept at anticipating new technology cycles and trends, such as AI, and “evolve accordingly”.

Taiwanese chipmaker, Taiwan Semiconductor Manufacturing Company (TSMC), the world’s leading semiconductor manufacturer, is a great example of a ‘tech enabler’. “We identified TSMC at the early stages of its development and have held the stock since 1998,” points out Citron, adding that it is a holding that consistently brings in high levels of profit, strong cash flows and an excellent dividend policy.

Energy and utilities are another part of the emerging markets story, and one Sudarshan Murthy, who manages the GQG Partners Emerging Markets Equity fund, likes very much. He has recently added to these areas, where he is already overweight.

“If the global economy continues to slow, or even enters a mild recession, our perspective is that demand for oil and natural gas will not decline materially,” he says, though this could change on the downside in the case of a deep recession, he admits.

Murthy has observed a renewed focus on profitability from many energy companies and a commitment from their management teams to return capital to shareholders, with the energy names he owns expected to pay “meaningful dividends”, which may cushion some of the potential volatility in their stock prices. 

His utilities exposure is tilted towards India, which he believes is “in the early innings of an infrastructure spending cycle to drive economic growth and improve the country’s competitiveness”.

Supporting this view is India’s National Infrastructure Pipeline, a government programme that has announced more than 9,000 projects totalling $1.4trn, emphasising energy and power, as well as roads and railways.


Emerging markets are enjoying a relatively favourable macroeconomic and monetary policy outlook.  Several central banks across the region are shifting to a dovish stance, after a long period of hawkish monetary policy and interest rate increases.

Kunjal Gala, head of emerging markets on the team at Federated Hermes that runs the Global Emerging Markets SMID Equity fund says: “This trend is likely to continue, making it cheaper to borrow money and boosting economic activity in emerging markets.”

The developed world is still facing high wage growth and inflation, which Gala expects will keep central banks relatively hawkish, while emerging economies enjoy lower interest rates.

Yet emerging market equities “remain volatile, due in part to increasing pressure from the rising US bond yield, the stronger US dollar, and China’s economic woes”, Gala admits, and these factors are hurting EM growth stocks more than value.

That said, Gala “remains optimistic about the future”, which, after all, is the hallmark of all real emerging market investors.

Darius McDermott is managing director, Chelsea Financial Services and FundCalibre. The views expressed above should not be taken as investment advice.

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