Three things we are thinking about today
- Foreign institutional investor (FII) flows into India. Investor flows turned positive in March following a recovery in the equity market, with US$15 billion in flows year-to-date through the end of July.1 India’s ability to capture an increasing share of foreign institutional flows into emerging markets reflects an improvement in the market’s risk-return profile. Factors include growth-oriented policy continuity, a reduction in inflation and the twin deficits (fiscal and current account balances), and increased spending toward infrastructure projects that increase capacity and productivity.
- Consensus expectations for the MSCI Emerging Markets Index reflect a 9% decline in earnings per share during the first half of 2023.2 The primary countries driving the earnings weakness are Taiwan, related to the semiconductor industry, and Brazil, related to the energy sector. Investors are expecting an improvement in the outlook for semiconductor demand to lead a recovery in the second half of 2023. These expectations are providing support to the MSCI Emerging Market Index, which gained 6.3% in July 2023.3
- Food prices. Following Russia’s decision not to renew the Black Sea grain initiative with Turkey and the United Nations, the price of wheat increased 10% in July 2023.4 Prices of other agricultural commodities have also increased; Thai rice was up 10% and palm oil prices have increased 20%.5 In combination with the confirmation of the El Niño climate phenomenon in the second half of 2023, there are upside risks to emerging market inflation. We are monitoring this for signs it is impacting margins of companies in the consumer staples sector.
Outlook
In our view, emerging markets (EMs) are filled with opportunities for growth. Individual countries are focused on strategies and policies to spur their respective economies. We see upside potential as the policy picture and growth prospects improve.
Chinese authorities have followed through with plans to stimulate domestic consumption within the automobile, property and leisure industries, among others. We believe this precedes the implementation of concrete policies to shore up the economy, which, coupled with elevated household savings, will drive the premiumization opportunity at the heart of the EM consumption story. We are aware that more substantive policies and a rebound in consumer activity is a prerequisite for gains in Chinese equities to persist, and we remain watchful for such developments.
Outside of China, we are of the view that the semiconductor industry is starting to recover, and an inflection point in terms of memory prices could occur as early as the third quarter of 2023. This presents opportunities for Taiwan and South Korea. Domestic battery and solar energy companies in South Korea may also benefit from the US Inflation Reduction Act. In India, we believe that there are still pockets of reasonable valuations, and there is still room for Indian equities to post further gains as earnings improve. We are also watching Brazil closely—an improving inflationary environment opens the door to possible monetary easing, thus benefiting corporate earnings.
We believe that a bottom-up approach is key to unearth companies set to benefit from these drivers. As fundamental, high-conviction investors in structurally competitive and well-placed businesses, our on-the-ground presence and experience enables us to uncover investment opportunities that translate into a well-diversified portfolio with low directional bias.
Emerging markets key trends and developments
EM equities started the second half of 2023 on a good note, gaining ground in the month of July and outpacing their developed market counterparts. Encouraging US macroeconomic data and enhanced clarity on China’s plans to shore up growth pushed markets higher. For the month, the MSCI Emerging Markets Index advanced 6.29% while the MSCI World Index gained 3.39%.
Emerging Asian equities advanced as all countries managed to eke out gains. China was the best performer as authorities rolled out plans to revive domestic consumption, spur private investment and support the real estate market. Chinese technology stocks also rallied after signals that the years-long regulatory crackdown has ended, with authorities now pledging more support for the sector. India outperformed on the back of strong corporate earnings. Stocks in South Korea and Taiwan also managed to rise, but gains were capped after two notable heavyweights—chipmakers Samsung Electronics and Taiwan Semiconductor Manufacturing Company—reported disappointing earnings results for the most recent quarter.
Emerging Europe, Middle East and Africa was the best performing region. Turkish equities led gains over hopes of a gradual policy normalization. The South African rand strengthened against the US dollar, reaching a three-month high. South Africa’s central bank also left interest rates unchanged on improving economic conditions. In the Middle Eastern region, central banks mirrored the US Federal Reserve and raised interest rates. Qatar also reported new long-term contracts with Asian buyers for gas, while the United Arab Emirates announced plans to double the contribution from its industrial sector to its gross domestic product.
All major equity benchmarks in the Latin American region also posted gains, with macroeconomic data taking centerstage in the region. Consumer prices in Brazil and Mexico fell; Brazil’s government also introduced taxes on sports betting. Chile’s interest rate cut of 100 basis points boosted sentiment, sending local stocks higher.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.
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1. Source: SEBI/Central Depository Services. July 31, 2023.
2. Source: Bloomberg as of August 1, 2023. There is no assurance that any estimate, forecast or projection will be realized.
3. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
4. Source: Chicago Board of Trade, August 1, 2023.
5. Source: Bloomberg, August 1, 2023.