Emerging Markets Quarterly Outlook

April 2023*

Navigating Risks and Capturing Opportunities

Emerging markets are navigating a challenging global environment, but the broader index continues to offer value. Allocation themes are unchanged from the previous quarter. A desynchronised cycle favours Asian economies with solid fundamentals and attractive value.

Global activity data was strong over the first quarter of the year. The global PMI composite index rose five points to 53.4 in March, while the Global Citi Surprise Index also increased into positive territory. Inflation remained elevated, but disinflationary trends helped ease some concerns. Overall, the growth backdrop was resilient in Q1. However, dark clouds started to form following recent banking stress in the US and Europe. The swift response from policymakers contained the immediate strains in the financial system. But the knock-on impacts will likely result in tighter credit conditions going forward, which raises global recession risks later this year.  

We do not expect emerging market (EM) equities to be immune to these events and potentially new stressors emanating from lagged monetary policy impacts. Historically the MSCI EM Index has a high beta to the global cycle and sensitivity to Fed hiking cycles. However, the relative case for EM equities remains solid. EM financials have outperformed developed market (DM) financial indices since March. EM banks were already responding to higher interest rates and domestic factors (e.g., China’s property bubble). In addition, the MSCI EM Index’s negative correlation to the US dollar (USD) has not derailed the relative support for EM. The USD is expensive on standard valuation metrics, while US interest rate differentials are peaking. These factors reduce safe-haven support for dollars and improve the medium-term outlook for EM assets.

Our key allocation themes are unchanged from the previous quarter. This year, a services-led recovery in China supports a desynchronised cycle, favouring the EM Asia region. Our country allocation continues to tilt towards ASEAN within Asia. We stay overweight to Vietnam, Indonesia, and Malaysia. Semiconductors remain in a downcycle, but we are increasing our allocation  in anticipation of a trough in semiconductor sales. We stay overweight Taiwan and upgrade South Korea to neutral. Finally, the longer-term prospects for energy exporters like Saudi Arabia remain attractive as the country diversifies towards its non-hydrocarbon economy. A global slowdown is a risk for the broader commodity complex, but the recent OPEC+ production cut announcement highlights some oil price support as net supply remains tight.

Geopolitics remain an essential consideration for EM. The US-China relationship remains tense and we cannot rule out a further escalation. Despite this risk, the two nations remain closely intertwined economically, and are strongly incentivised to maintain trade relations in a lower-growth environment. Longer-term, the US-China strategic rivalry will continue to drive US supply chain readjustment towards ‘friend-shoring’ over a multi-year period. ASEAN remains our preferred exposure to capture this trend. 

Market Strategy: Our EM allocations remain positioned for a desynchronised cycle favouring the Asia region and attractively valued indices. Relative to the previous quarter, we make the following adjustment to the existing country allocations:

  • We upgrade South Korea to neutral. South Korea ranks high on our fundamental framework and looks attractive over a longer-term horizon. DM index inclusion is also a potential upside risk in the coming quarters. Semiconductors remain in a downcycle, and South Korea is historically one of the most cyclical markets and recession risks loom. Subject to that, we expect a better semiconductor supply-demand balance in 2H as the downcycle approaches a trough.

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 31 March, 2023, and macro events and data releases up to 12 April, 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.