Emerging Markets Quarterly Outlook

April 2024*

Strong Earnings Growth Supports a Re-Rating

Emerging market equities have had a slow start to the year, but some headwinds have faded or even reversed. Demand for semiconductors is growing, supporting EM Tech stocks (predominantly South Korea and Taiwan). Overall, EM earnings can grow this year and support a re-rating as AI adoption results in further demand for advanced chips. This quarter, we upgraded South Korea to overweight, funded by trimming our Taiwan and Saudi Arabia overweights.

Emerging Markets (EM) have rebounded this year in absolute terms but have underperformed the MSCI All Country World Index (ACWI). We attribute EM’s underperformance in recent years to a) ‘US exceptionalism’ and a stronger USD; b) the 2022-23 semiconductor downcycle weighing on large EM Tech stocks; and c) China outflows linked to various structural issues and geopolitics. We expect some of these factors to become less of a headwind. In particular, semiconductor demand is already shifting to a strong tailwind as artificial intelligence (AI) growth further supports the demand for advanced chips.

EM earnings growth projections remain robust this year at 20% yoy, and the index trades at a modest 13x forward multiple. EM earnings growth can outpace developed markets (DM) due to a cyclical rebound in semiconductor sales and structural demand for advanced chips. The two primary semiconductor exporters, Taiwan and South Korea, have a combined weight of approximately 30% in the MSCI EM Index, which is more significant than China (about 25%) and India (about 18%) as of end-March. As noted by CEO Jensen Huang in the most recent Nvidia earnings release, “Accelerating computing and generative AI have hit the tipping point. Demand is surging worldwide across companies, industries, and nations.” EM equities offer attractive exposure to these trends given its ‘moat’ in advanced semiconductor manufacturing. Our allocations reflect an overweight bias to EM Tech.

A strong China rebound is not a requirement for the broader EM index to outperform. However, a trough in Chinese stocks is likely required following yearly declines over 2021-23. China continues to be plagued by structural headwinds, including a declining property sector, deflation, weak consumer confidence, unfavourable demographics, high youth unemployment, and elevated US-China geopolitical risks. Some of these factors may improve this year; however, some headwinds will likely remain. On a more optimistic note, we believe China’s current valuation implies positive annualised returns over the next five years based on historical data. In addition, a sharp spike in domestic ETF flow data suggests that policymakers (via the ‘national team’) have been actively supporting the domestic stock market. Given these factors, benchmark investors may look to reduce underweight exposure, providing some support for stocks. We maintain a neutral allocation, but our bias has become more positive. 

In the rest of the EM universe, the upcoming elections in India (April-June) and South Africa (May) may be relevant for our underweight positions. In India, we expect Modi to win a third consecutive term and the long-term growth narrative to remain intact. However, India’s stock market valuation is unattractive and leaves little room for disappointment in earnings and politics relative to other parts of EM. In South Africa, we expect the ANC to stay in power but will likely lose its majority and require a coalition government based on current polling. These dynamics leave some uncertainty around the election outcome while domestic issues (e.g. power outages) remain unresolved. 

Market Strategy: Relative to the previous quarter, we made one change to our country allocations: 

  • We upgrade South Korea to overweight. We expect earnings to rebound strongly this year based on a cyclical rebound and structural demand for high-bandwidth memory (HBM) linked to AI growth. South Korea’s Corporate Value-up initiative provides a potential long-term upside opportunity but is not a central assumption for the upgrade. We fund our upgrade by trimming our Taiwan and Saudi Arabia overweight. Overall, our EM semiconductor exposure remains overweight.

EM Country Allocation

  Chg -2 -1 0 +1 +2
South Korea        
Latin America
Europe, Middle East and Africa
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 March 2024, and macro events and data releases up to 5 April 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.