Outlook 2024: EMD – Shifting the focus back to emerging markets
Outlook 2024: EMD – Shifting the focus back to emerging markets
Alejandro Arevalo and Reza Karim explain why they think 2024 could be a strong year for emerging market debt, as attention returns to the positive stories in EM.
Undoubtedly, there have been several significant shocks to risk assets over the past few years – Covid-19, the war in Ukraine, high inflation, and a higher interest rate environment following years of very low rates (especially in developed markets). Concerns around these themes have rocked both developed and emerging markets, but as we look to 2024, we expect to see a much more positive, calmer backdrop, with fewer shocks to markets, particularly for EM.
For some time now, the emerging market debt (EMD) asset class has been hurt by the higher rates on offer elsewhere, as many investors have not felt the need to look beyond Treasuries in their search for higher yields and greater total returns. However, the consensus view is that we are now at peak rates in developed and emerging markets, with rates most likely to start coming down in 2024, which should be beneficial for EM. Indeed, we are already starting to see a shift in sentiment in terms of investors trying to maximise returns and yields.
For some time now, the emerging market debt (EMD) asset class has been hurt by the higher rates on offer elsewhere, as many investors have not felt the need to look beyond Treasuries in their search for higher yields and greater total returns. However, the consensus view is that we are now at peak rates in developed and emerging markets, with rates most likely to start coming down in 2024, which should be beneficial for EM. Indeed, we are already starting to see a shift in sentiment in terms of investors trying to maximise returns and yields.
Improving environment
In 2024, we believe that many of the risks that EMD has faced over the past few years – headline risks, geopolitical risks, higher interest rates across developed markets, and notable outflows from the asset class – should start to abate or disappear entirely. As a result, we think investors’ focus will turn away from the negative external market drivers towards the positive internal drivers in EM.
Many market participants are firmly focused on the hard/soft landing debate in the US, but we view this outcome as less important for emerging markets. While we acknowledge that the worst-case scenario could result in a sell-off in developed markets, which would most likely result in some contagion in EM, the most important factor for us is that rates will start coming down regardless, which over time should benefit the broader EMD asset class.
Most EM countries are expected to reach their target inflation rates by the end of 2024, and as with developed markets, EM central banks are also widely believed to have reached peak rates. Furthermore, rate hiking cycles in EM started well before those in developed markets, meaning that EM central banks are sitting on a meaningful cushion of positive real rates, which could help to ease monetary policy and support economies down the line. While we expect EM growth to be a bit softer as we enter the new year, in terms of the growth differential, we anticipate seeing a sustained return to stronger growth coming from EM than developed markets.
In terms of other headwinds, while China has struggled with weaker growth numbers and the popping of its real estate bubble, we have been pleasantly surprised that these factors haven’t had much of an impact on EM broadly speaking. Furthermore, we believe we have seen a bottoming out in Chinese markets and sentiment, and therefore expect to see some improvement there as the year progresses, as monetary and fiscal policies have demonstrated that the Chinese government has become increasingly willing to support the economy in terms of growth.
Over the past couple of years, we’ve seen higher-than-average default rates in EMD, largely driven by concerns around the Chinese real estate sector and the ongoing war in Ukraine. However, we also anticipate a significant improvement in terms of default rates for 2024, with forecasts falling to closer to long-term averages given weakening risks.
Many market participants are firmly focused on the hard/soft landing debate in the US, but we view this outcome as less important for emerging markets. While we acknowledge that the worst-case scenario could result in a sell-off in developed markets, which would most likely result in some contagion in EM, the most important factor for us is that rates will start coming down regardless, which over time should benefit the broader EMD asset class.
Most EM countries are expected to reach their target inflation rates by the end of 2024, and as with developed markets, EM central banks are also widely believed to have reached peak rates. Furthermore, rate hiking cycles in EM started well before those in developed markets, meaning that EM central banks are sitting on a meaningful cushion of positive real rates, which could help to ease monetary policy and support economies down the line. While we expect EM growth to be a bit softer as we enter the new year, in terms of the growth differential, we anticipate seeing a sustained return to stronger growth coming from EM than developed markets.
In terms of other headwinds, while China has struggled with weaker growth numbers and the popping of its real estate bubble, we have been pleasantly surprised that these factors haven’t had much of an impact on EM broadly speaking. Furthermore, we believe we have seen a bottoming out in Chinese markets and sentiment, and therefore expect to see some improvement there as the year progresses, as monetary and fiscal policies have demonstrated that the Chinese government has become increasingly willing to support the economy in terms of growth.
Over the past couple of years, we’ve seen higher-than-average default rates in EMD, largely driven by concerns around the Chinese real estate sector and the ongoing war in Ukraine. However, we also anticipate a significant improvement in terms of default rates for 2024, with forecasts falling to closer to long-term averages given weakening risks.
Rapid inflows in 2024?
Given the improving backdrop and the breadth of positive drivers for EM this coming year, we anticipate seeing a return of inflows into the asset class. In terms of trends, when we see a return to inflows into EMD, we tend to see assets being deployed very quickly, rather than it being an asset class that attracts gradual flows. While we do not try to predict timing of flows, we do anticipate seeing investors return to the asset class in 2024, and we are positioned accordingly.
Cognisant of the risks
As always, we continue to monitor developments in terms of ongoing risks too. 2024 will be a very busy year for elections in EM, and we recognise the risks that come with that uncertainty. Nevertheless, as we have discussed previously, we tend to see less contagion across EM than we used to in the past, meaning that political risk tends to have a limited impact on the broader asset class. There are also several important elections taking place in DM in 2024, particularly in the US, which could have a knock-on effect elsewhere. However, historically, we tend to see a relief rally in EM assets following the US election outcome, given an end to the uncertainty election periods bring.
Outside of politics, we also recognise meteorological risk as one of the key risks for EM. We have been hearing more commentary coming from central banks regarding El Niño, given its significant potential impact on EM food price inflation, with food representing a significant proportion of consumer spending in EM. We will continue to monitor these risks as we enter the new year.
Outside of politics, we also recognise meteorological risk as one of the key risks for EM. We have been hearing more commentary coming from central banks regarding El Niño, given its significant potential impact on EM food price inflation, with food representing a significant proportion of consumer spending in EM. We will continue to monitor these risks as we enter the new year.
Shifting focus to local stories
As we look ahead to 2024, we think market participants will refocus on EM stories once again – the EM/DM growth differential, weakening inflation, central bank independence and strong consumer growth across EM.
Right now, valuations are not in line with fundamentals in certain parts of EM – valuations are wider, while fundamentals have not weakened as much as markets had expected over the past few years. A combination of wide valuations and strong fundamentals, along with several potential tailwinds for 2024, means that we are positive about the outlook for the asset class in the year ahead.
Given an improving backdrop in terms of local EM themes, we have been moving our exposure away from global exporters, towards those areas that we believe should benefit from the local economy and stronger consumer demand, including consumer sectors, telecoms, utilities and banks. As always, we believe a diversified but selective approach is key.
Right now, valuations are not in line with fundamentals in certain parts of EM – valuations are wider, while fundamentals have not weakened as much as markets had expected over the past few years. A combination of wide valuations and strong fundamentals, along with several potential tailwinds for 2024, means that we are positive about the outlook for the asset class in the year ahead.
Given an improving backdrop in terms of local EM themes, we have been moving our exposure away from global exporters, towards those areas that we believe should benefit from the local economy and stronger consumer demand, including consumer sectors, telecoms, utilities and banks. As always, we believe a diversified but selective approach is key.
Outlook 2024: A pivotal year?
Periods of transition often raise interesting questions, and this year investors are faced with plenty as they look ahead to what 2024 may bring. Will Western central banks finally start cutting interest rates? Will geopolitical tensions calm or further escalate? And what might a fraught US Presidential election mean for the world?
Outlook 2024 Articles
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Important information