Emerging Markets Quarterly Outlook

July 2023*

Focussing on Strategic Opportunities

EM equities continue to face challenges, but the broader index should benefit from targeted Chinese policy stimulus and a peak in the US terminal rate this year. Our country allocations continue to focus on fundamental value opportunities and strategic thematic drivers such as AI/advanced semiconductor demand and global supply-chain readjustment.

Global growth remained resilient in the first half of the year, but there was evidence of a loss of momentum going into 2H23. In June, the global PMI composite index decelerated to an above-trend 52.7, while the Citi global economic surprise index fell into negative territory. Regionally, economic activity was not uniform. The US data remained consistent with trend-like growth despite further tightening in monetary policy, while the eurozone recorded a mild recession. China’s recovery showed signs of stalling following a significant run of weak data in recent months. We expect China will be able to achieve its growth target this year of “around 5%”. However, depressed consumer confidence and continued weakness in the property sector will present challenges for next year’s growth target without policy action. The July Politburo meeting is the most likely date for additional stimulus announcements to help stabilise activity. While China’s growth is unlikely to materially exceed its growth target this year, its lower inflation and easier policy still leave it relatively well-placed to maintain trend growth compared to its DM peers. 

Our broader EM equity view remains constructive despite ongoing challenges. Additional stimulus and stabilisation in China’s growth momentum should support EM equities, which continue to trade at a low 12m forward P/E multiple of 12x. The US monetary cycle remains a headwind for EM assets, but we continue to expect a peak in the Fed’s terminal rate this year. This shift should weaken support for the US dollar, providing some relief for EM. Furthermore, the recent AI focus is an added upside risk for EM equities, given its significant weighting to semiconductor stocks that are direct beneficiaries of generative AI.

Our country allocations continue to focus on key themes within the index. Growing demand for advanced chips and further evidence of a trough in global semiconductor sales favour EM Technology exposure. Taiwan remains our preferred overweight. Nearshoring or friend-shoring trends benefit ASEAN countries with robust earnings growth and lower geopolitical risk than China. We stay overweight Vietnam, Indonesia, and Malaysia within ASEAN. In addition, we upgrade Mexico to neutral from underweight, given the recent acceleration in foreign direct investment flows and still cheap valuations. India is also a beneficiary of a US supply chain readjustment; however, India’s elevated P/E multiple leaves limited price upside. We therefore remain underweight. Finally, our broad commodity outlook is balanced, but we see better long-run prospects for Saudi Arabia (overweight) relative to South Africa (underweight), as explained in the country sections.

We continue to monitor major geopolitical events, given that EM equities are exposed to the strained US-China relations. US Secretary of State Blinken’s recent visit to China may be an initial step towards some moderation in tensions, which may help reduce the geopolitical risk priced into Chinese equities. However, the US-China strategic rivalry will continue to drive US supply chain readjustment over the long run. In Russia, the recent ‘coup’ attempt is not an obvious driver of the MSCI EM Index, which now excludes Russia. Nevertheless, we are cognizant that greater instability within Russia does raise tail risks that could spread (e.g., an oil shock). 

Market Strategy: Our EM allocations remain positioned to benefit from strategic themes (e.g., advanced semiconductor demand, nearshoring/friend-shoring) while focusing our conviction on countries where we see value. Relative to the previous quarter, we make the following adjustment to the existing country allocations:

  • We upgrade Mexico to neutral. We continue to see risks to Mexico’s earnings outlook. However, stronger FDI flows in Q1 suggest nearshoring trends may be gaining momentum. In addition, Mexico’s valuation measures have improved relative to the broader EM index over the quarter. Overall, Mexico’s risks have become more balanced.

EM Country Allocation

  Chg -2 -1 0 +1 +2
South Korea        
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.

Source: City of London Investment Management

*The publication reflects asset performance up to 30 June 2023, and macro events and data releases up to 7 July 2023, 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.