Three things we are thinking about today:
- BRICS1 expansion: The BRICS summit in South Africa in August announced the expansion of the group to include potentially six new members in early 2024. The BRICS+2 grouping continues to focus on building a multipolar world and giving a voice to developing countries, also known as the Global South. The inclusion of three Middle Eastern countries has implications for global energy security as it raises the group’s share of global oil reserves to 41%.3 It will also increase the relevance of the New Development Bank, the BRICS multilateral lending organization which has loans and investments of US$21 billion.4 The expansion of BRICS may create new investment opportunities that our on-the-ground presence can uncover.
- Impact of deflation on Chinese consumption: Chinese consumer prices declined 0.9% in July, and producer prices dropped 4.4%. There is increasing anecdotal evidence that Chinese consumers are postponing purchasing decisions for goods due to expectations of falling prices. This contrasts with the continued appetite among consumers to spend on services. The Consumer Price Index service component remains in positive territory, rising 1.2% in July. Travel, leisure and health services are proving to be more resilient parts of the Chinese economy. Nevertheless, until confidence improves in the real estate sector, Chinese households are expected to remain cautious in their spending decisions.
- Global trade: The world’s largest shipping company recently revised down its forecast for global container demand, a proxy for global trade, to between 1% growth and a 4% contraction.5 The forecast is consistent with the 18% decline in an index of global container shipping costs6 this year. Given the importance of trade and manufacturing to emerging markets, the continuation of the destocking cycle is a concern. Nevertheless, in emerging markets there are new growth opportunities, including renewable energy, the electrification of transport and semiconductors.
Outlook
The interest-rate cutting cycle in emerging markets (EMs) is building momentum following rate cuts in China and Brazil. These moves echo rate cuts in other EMs such as Chile, Hungary and Peru. However, we are cognizant that there is no uniform trajectory for the direction of interest rates across EMs.
The onset of an easing cycle in selected countries tilts the balancing act of tackling inflation while pursuing economic growth toward the latter. The impact of a rate cut is positive for businesses as it reduces their financing costs—potentially boosting corporate earnings and spurring investment, which will reinvigorate the economy.
However, rate cuts affect banks differently. Monetary easily negatively impacts net interest margins (NIMs), which measure profitability. In our opinion, banks in EMs are experiencing strong credit demand, and a corresponding decrease in interest rates will not result in a dramatic squeeze on NIMs.
We are of the view that lower interest rates may help banks’ earnings as lower provisions could more than offset the impact of lower NIMs. In India, we believe that banks are beneficiaries of the anticipated acceleration in credit growth and increasing share of financial assets in household savings. India is also home to some well-run private sector banks with deposit franchises, which will enjoy improved pricing power and look poised to gain market share. In China, regulatory guidance is likely to continue to pressure interest rates down, but banks may also lower deposit rates to preserve NIMs.
In addition to rate cuts, there are other positive long-term factors in EMs that unlock potential investment opportunities. The increasingly popular China+1 strategy, where global manufacturers establish an additional overseas production base in China plus one other country, stands to benefit India, Mexico and several other ASEAN economies. The transition to a greener future is another longstanding theme. Asia is home to well-run companies in the electric vehicle and solar equipment segment, and Brazil is continuing its renewable energy push, with the government looking to support the fast-growing solar energy sector.
The bottom-up view of the investment landscape in EMs is what’s important to us. We find the opportunity set wide—and getting wider. Rigorous stock selection will be critical as investment opportunities and risks evolve. Our focused investment approach enables our on-the-ground teams to identify business models and management teams that display agility and resilience in a fast-changing world, often before our peers.
Market review
EM equities declined during the month of August, faring worse than their developed market counterparts. A downgrade to the US government’s credit rating and higher US Treasury yields dampened investor risk appetite globally. For the month, the MSCI Emerging Markets Index declined 6.13% while the MSCI World Index declined 2.35%.7
All equity markets in the emerging Asia region tracked lower, with China’s registering the largest losses. Disappointing economic data and liquidity problems plaguing the property sector weighed on investor confidence, as did a crackdown on the health care sector, which pressured health care and biotechnology-related stocks. Markets in South Korea and Taiwan fared slightly better than China, with export data pointing to a sluggish semiconductor market. However, strong results from some companies resulted in gains for technology-related stocks temporarily and helped to cap losses. India’s market was one of the best performers, but a new 15-month high in its annual retail inflation reading clouded the country’s stable macroeconomic fundamentals and strong corporate earnings.
The emerging Europe, Middle East and Africa region was the best-performing region on a relative basis, albeit still declining. Most countries suffered losses except for Hungary, Egypt and Turkey. A hike in Turkey’s interest rate was a strong signal of a return to orthodox monetary policy, which resulted in a rally in the lira and an improvement in investor confidence. The oil-producing nations of Saudi Arabia and the United Arab Emirates were among a group of countries invited to join the BRICS group of developing nations. Saudi Arabia also announced an extension of its oil production cuts and higher oil selling prices to Asia.
By region, Latin America was the worst-performer, with all equity markets in all countries recording losses. At the start of the month, Brazil commenced its rate-easing cycle—the first interest-rate cut in three years—and reaffirmed its commitment to further reductions. Its state-run oil company, Petrobras, announced that it will raise gasoline and diesel prices, which resulted in a rise in its share price and helped to cap losses for the country. Mexico’s market was the strongest regional performer across a backdrop of improving inflationary and gross domestic product data.
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. BRICS refers to the group of developing nations: Brazil, Russia, India, China and South Africa.
2. BRICS+ includes the original five BRIC countries with the addition of Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the UAE.
3. Source: Centre for Strategic and International Studies. “Six New BRICS: Implications for Energy Trade.” August 25, 2023.
4. Source: New Development Bank. March 2022.
5. Source: Maersk. August 2023. There is no assurance that any estimate, forecast or projection will be realized.
6. Source: Drewry World Container Index, August 31, 2023. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
7. 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.