July 2024*
Emerging market equities outperformed in Q2 due to the upturn in the semiconductor cycle and improving sentiment towards Chinese stocks. Valuations have yet to reflect EM’s strong earnings expectations, suggesting scope for re-rating. At the same time, the widely anticipated Fed easing cycle should provide a more conducive environment for EM. We maintain our allocations this quarter focusing our exposure on stocks linked to artificial intelligence via semiconductors, US-China decoupling, and decarbonisation.
Emerging Markets (EM) continued their solid performance in Q2, outperforming the MSCI All Country World Index (ACWI) by 2.1% points, as optimism over artificial intelligence (AI), strong semiconductor demand and improving sentiment on China helped stocks. Earnings for Q1 have generally been positive and above expectations. Forward earnings projections for this year point to a continuation in H2, with EM earnings (+22% yoy) expected to grow more than twice the pace of developed markets (10% yoy). Despite robust earnings expectations, the EM index still trades at a moderate 12x forward multiple.
We expect 2H24 to be a more supportive backdrop for EM as US rates fall and global growth moderates but stays firm. The global manufacturing PMI dipped to 50.9 in June, with the weakness in Europe offset by improvements in Asia. The US economy is showing signs of easing, and the Citi US economic surprise index is firmly in negative territory. Activity indicators in China have been mixed. The industrial sector is recovering faster than the consumer sector. No significant policy changes or support measures are expected to be announced at this month’s Third Plenum in China. Turning to inflation, the pace of US disinflation has been slower than anticipated, pushing back market hopes of easing. However, the policy bias still points towards rate cuts rather than rate hikes, which historically favours EM equity outperformance relative to the US.
Meanwhile, the conclusion of multiple EM elections in Q2 should remove some political and policy uncertainty. None of the election results materially changed our country views. In India, Modi won a third consecutive term, but his BJP fell short of an absolute majority, meaning controversial structural reforms are less likely to be passed. Indian equities plunged in response to the result and then recovered sharply. While the result does not change the long-term potential for India, we remain cautious about the sharp rise in speculative option contract volumes and the index’s elevated valuation multiple. In Mexico, the ruling Morena party won the Presidency and gained a supermajority in Congress. President-elect Sheinbaum is ideologically aligned with her predecessor AMLO, and the proposed constitutional reforms are a risk to institutions. Finally, in South Africa, the ANC was forced to form a coalition government with the more business-friendly DA party and smaller parties. At face value, the new government could be perceived as a positive for South Africa, but the fragility of the union keeps us cautious. As such, we have only trimmed our underweight position in South Africa. Outside of EM, uncertainty surrounding the upcoming US election could be a headwind for EM assets, with policies on trade and migration at risk.
Our strategic views are unchanged from last quarter. Our allocations reflect our key themes of 1) the semiconductor upcycle and the growth of generative AI (South Korea, Taiwan); 2) supply chain adjustments away from China (Vietnam, Malaysia); and 3) the energy transition (Chile, Indonesia). Mexico should also benefit from the second theme, given its proximity to the US. Still, we keep our neutral allocation at this juncture considering the local election result and the risks surrounding the upcoming US election.
Market Strategy: Relative to the previous quarter, we made the following changes to our country allocations:
| 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.
Source: City of London Investment Management
*The publication reflects asset performance up to 28 June 2024, and macro events and data releases up to 3 July 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.