Asset AllocationNovember 6, 2023

An EM Rebound—and It’s Not All About China

Why emerging markets, now in the doldrums, will come back, per Lazard.

Reported by Larry Light

Emerging market stock indexes have suffered, largely due to China’s economic stumbles related to its pandemic lockdown and the aftermath. China makes up 30% of the main exchange-traded fund tracking the EM space, iShares MSCI Emerging Markets. And the country’s thirst for EM raw materials extends its influence globally. But even leaving out China, many EM stocks have been disappointing in 2023.

The Shanghai Composite is down almost 18% from its highs at the end of 2021 and 2% this year, amid weakened corporate earnings growth and heavy debt burdens. Thus far in 2023, the MSCI Emerging Markets index is barely in the black, up 1.5%. But take out China, and the index is further ahead, up 7.5%. That’s still underwhelming: the S&P 500, reflecting the ongoing strength of the U.S. economy, has jumped 13.5%

But there’s some good news for EM investors ahead, according to Lazard Asset Management. The firm’s report declared that renewed stimulus from Beijing stands to perk up China economically—and its shares. Even better, the Lazard report explained, many other EM nations have the ingredients to power ahead next year, independent of China’s trajectory.

The latest rescue plan from the Chinese government, Lazard wrote, should be a tonic, as it has been in the past: “For the country’s troubled real estate sector, down payment requirements for mortgages have been reduced, while banks have been encouraged to lower interest rates.”

Moreover, earnings in China and other EM nations are looking better up ahead. Non-China EM businesses in many cases don’t carry big debt burdens and tend to have a lot of cash, Lazard researchers and other strategists maintain. In 2024, the Lazard report noted, EM companies are projected to post an average 19% earnings growth, compared with 10% for the U.S., per FactSet Research.

In Asia, outside of China, and in Latin America, escalating interest rates are not much of a problem, says Alia Yousuf, CEO of Singapore-based Global Evolution, an EM-oriented subsidiary of asset manager Conning Holdings Ltd. “In Asia, they were the last ones to hike due to low inflation,” she pointed out. In Latin America, where inflation has been high, a lot of central-bank tightening already has occurred to combat spiraling prices, she adds.

Other “big drivers” to watch out for, she says, are the Federal Reserve’s monetary policy and U.S. Treasury bonds’ behavior. How these two forces fare affects the now-strong U.S. dollar, which is a potent influence in international trade.

The health of EM investments is important to allocators in the U.S. and the West. The New Jersey Division of Investment, for instance, had 4.9% of its portfolio in EM equities, as of June 2023—shy of its long-time target of 5.5%, because the plan wanted to keep a defensive posture amid market volatility.

Right now, EM stocks are pretty cheap, Lazard observes. Their valuations are 30% below those of developed market stocks and 35% below U.S. equities, the firm stated.

Economic trends are very encouraging for many EM economies and shares, in Lazard’s view. “Emerging markets’ economic growth is now starting to move higher as developed markets’ growth slows, and emerging markets are being driven by more than just China,” Lazard wrote.

India, for example, has a demographic tailwind, with 80% of its population younger than 50. In Latin America, mainly Brazil and Mexico, in-migration of manufacturers from China to be closer to the U.S., a phenomenon known as “nearshoring,” will be a big boon, Lazard contended.

Opportunities also abound in EM debt. Often, EM bonds are attractive because they sport higher yields than U.S. paper: on average around 9% for emerging market sovereign debt, per Bloomberg statistics. India’s 10-year government bond yields 7.3%. Global Evolution’s Yousuf recommends high-yield EM corporates, as they pay even more than EM sovereign debt.

Overall, she went on, given the range of EM capabilities—from Latin America’s commodities to Asia’s technology—emerging nations represent “a good, diversified asset class.”