October 2024*
Emerging market equities outperformed in Q3 due to Fed rate cuts and growing expectations for more aggressive policy stimulus in China. In addition, semiconductor demand linked to Artificial Intelligence (AI) remains a strong tailwind for EM earnings growth. This quarter, we upgraded our China allocation to overweight (via A-shares). We expect the domestic stock market to benefit the most from Beijing’s policy shift, while China proxies (e.g. commodity exporters) may see less upside. We downgraded Saudi Arabia to neutral and Brazil to underweight. Our existing allocations focus on stocks linked to AI via semiconductors, US-China decoupling, and decarbonisation.
Emerging Market (EM) equities have been plagued by underperformance relative to Developed Markets (DM) since 2021. This underperformance was partly driven by a semiconductor downcycle over 2022-23 and negative sentiment towards China. This year has marked a notable shift, with EM ex-China rising close to previous highs (see Chart 1) due to EM semiconductor stocks benefitting from AI growth. In recent weeks, a similar potential breakout has occurred for the broader EM index, led by Chinese equities. The combination of China’s policy announcements and Fed rate cuts provides a strong tailwind for EM and Chinese stocks.
The Fed’s 50bp cut in September was an important event for China and EM. EM stocks have typically outperformed the US and DM in the six months following the first rate cut (see Chart 2). In addition, the decline in US rates has weighed on the US dollar, which is historically associated with better EM and China stock performance. A weaker US dollar allows the People’s Bank of China (PBoC) to implement more aggressive easing measures without destabilising its currency. Overall, a Fed easing cycle is a positive development for China and EM.
In China, recent policy announcements represent a notable shift from past disappointments. The PBoC delivered multiple monetary easing measures indicating urgency, and the off-cycle Politburo meeting provided more explicit signals to stabilise the property market and support economic activity. We expect further announcements on fiscal policy this year. New tools were also unveiled to support the domestic equity market, including 500bn RMB asset swap facilities to non-bank financial institutions for equity investing and a 300bn RMB re-lending program for corporate buybacks. These tools provide further evidence of policymakers’ commitment to supporting the domestic stock market following capital market reforms (e.g. the State Council “nine-point guideline”) and direct equity buying from the state funds (i.e. the ‘national team’) this year.
Analysts are now debating if these policies are a ‘game-changer’ and China’s version of “whatever it takes” (in reference to former ECB President Mario Draghi’s 2012 quote that helped lift the Eurozone out of crisis). In our view, the policy shift is a notable improvement requiring investors to reassess persistent negative sentiment and positioning over recent years. The sharp rebound is justified in the context that the MSCI China Index was trading at a very depressed forward P/E of 9x in September (it is now closer to 11-12x). Some profit-taking is a short-term risk, given the speed and magnitude of the rally. Still, previous China stock market rallies since 2005 indicate more upside if authorities continue to deliver economic and capital market support (see Chart 3). We expect further strength and have upgraded our allocation to mainland China equities.
| Chg | -2 | -1 | 0 | +1 | +2 | |
|---|---|---|---|---|---|---|
| Asia | ||||||
| China* | ↑ | |||||
| South Korea | – | |||||
| Taiwan | – | |||||
| Malaysia | – | |||||
| Indonesia | – | |||||
| Philippines | – | |||||
| Thailand | – | |||||
| Vietnam | – | |||||
| India | – | |||||
| Latin America | ||||||
| Brazil | ↓ | |||||
| Mexico | – | |||||
| Europe, Middle East and Africa | ||||||
| Turkey | – | |||||
| Saudi Arabia | ↓ | |||||
| South Africa | – | |||||
Note: Up/down arrows indicate a positive/negative change in our asset allocation compared to the previous quarterly outlook. A dash indicates no change. The table shows the major Emerging Markets.
*Allocation is overweight China (via OW A-shares and N offshore stocks).
Source: City of London Investment Management
*The publication reflects asset performance up to 30 September 2024, and macro events and data releases up to 8 October 2024, unless indicated otherwise.
The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.