There’s an old adage for emerging market (EM) investors that things are never as good nor as bad as they seem. Indeed, this uncertain middle ground is where we’ve found ourselves this year. We’ve seen a global rate hiking cycle, while the NASDAQ has outperformed; meanwhile, Sino-US geopolitical tensions have continued, yet we’ve still seen record-high trade levels between the two countries. These dichotomies have made it challenging to read the tea leaves for the path forward for the global economy.

However, there are a few things we know for certain. Firstly, EM fundamentals look very strong relative both to history and to developed markets (DM). Secondly, China has clearly underperformed this year, but we’re now seeing green shoots that suggest we’ve reached the bottom. And thirdly, it seems like interest rates have peaked for this cycle, with some EM central banks starting to cut.

Strong EM fundamentals

EM economies have recorded the strongest relative headline lead indicators since June 2009, and, even including China, the aggregate EM purchasing managers index (PMI) is near its highest level ever. This already strong backdrop is overlaid with supportive EM central banks and attractive equity market conditions. For example, for the first time in history, EM interest rates are forecast to fall below DM rates over the next four quarters (in aggregate).

But it’s not just their economies that look attractive. From a stock market valuation perspective, the cyclically adjusted P/E ratio for the MSCI EM Index (a measure of stock prices against earnings throughout the business cycle) is trading at 10.7x, approximately one third of the level of the S&P 500 Index (29.5x). This means that EM equities are not only presented with the most fertile growth conditions for a decade, but they are also very attractively priced relative to DM (in aggregate).
China: not as bad as the headlines?
China continues to attract sensationalist headlines proclaiming that we’ve reached ‘peak China’ or insisting it is the ‘new Japan’. However, while it is clear that China has been performing badly, we think much of this is overblown.

The government recently stepped up its response to its ongoing property sector woes, announcing a raft of stimulus measures. China is a policy-driven economy that relies on policies, symbols and nudges to achieve its goals. These announcements are a meaningful step in the right direction, with the central government ‘tone from the top’ particularly important. We have seen encouraging early signs, though we do recognise it’s still too early to infer causality.

The government has also continued to focus on ‘activating’ the capital market in China. This will be important for reinvigorating Chinese investor confidence in equities. Finally, these concerns should be put in the context of the opportunities for the country: China is the world’s second largest economy and will remain so for some time to come, regardless of geopolitical tensions, with domestic consumption continuing to increase. Chinese GDP per capita has increased by 14-fold, from 2% of US GDP per capita in 1980 to 28% today. If it were to achieve the same level of prosperity as Poland, for example (46%), over the next 20 years, its GDP per capita would double. We don’t try to forecast macroeconomic data, but this gap would suggest that there is a long way for China to run before it catches up to its emerging European peers – a not outrageous expectation.

Peak interest rates

Finally, turning to interest rates, it’s clear from both policy decisions and rhetoric that developed market central banks – the US Federal Reserve, the Bank of England, and the European Central Bank to name three – are at or near their peaks for this tightening cycle. Emerging market central banks have already begun to cut rates, with recent announcements coming from China, Brazil and Chile. We believe that the availability of cheaper financing in emerging markets, combined with the relative attractiveness of equity returns versus fixed income returns, should support both companies and stock market returns moving forward.

Globalisation, but not as we know it

Casting our views further into the future, we think the world could be on the precipice of an epochal shift in economic growth. Over recent decades, global economic growth has come from two sources: China and the US. For China, this has been fuelled by exports, while the US has benefitted from cheap shale energy and cheap money. Continued economic integration and globalisation have meant that all investors have benefitted from these tailwinds, but similarly, they have been subjected to their whims. The events of the past three years have shown that this paradigm has shifted: we no longer live in the same globalised world that we did. In particular, the West’s sanctions of Russia have made many non-Western companies and individuals think twice about being caught out by the Western system. Much of the appeal of the West, particularly for businesses in emerging economies, has been its rule of law and respect for private property rights, regardless of nationality – but this has been upended. The additional complications of heightened geopolitical tensions have driven a splintering of global spheres of influence. Direct trade between countries, bypassing the US dollar, is becoming increasingly common, with regular reports of direct commodity transactions in Chinese renminbi and Indian rupees, and even calls for a united BRICS currency – an outcome we view as unlikely, but still indicative of the discomfort felt by countries reliant on the US dollar for trade.

What does this mean for investors? In our view, it means that global trade and economic growth may be less dependent on the fortunes of these two nations, and more dependent on cross-border investment between countries, which could be very positive for EM in aggregate. Already, the share of trade between EM countries is more than 40% of total EM exports. Emerging markets constitute the world’s last great engines of growth: they have vast, young populations; they’re well educated and entrepreneurial; they’re rapidly growing their wealth; they benefit from inbound and domestic capital investment; and they are increasingly run by fiscally conservative, stable governments. Greater integration of EM economies helps support this growth and reduce reliance on the slower-growing developed world. Furthermore, the historically strong negative correlation between EM equities and the US dollar may be weakening, allowing the attractive fundamentals of these countries to shine.

Ripe conditions for EM

Emerging markets offer investors access to some of the most structurally advantaged growth opportunities on the planet. World-class businesses, favourable demographics, and low-cost and highly skilled labour forces make emerging markets an exciting universe to invest in. We believe our style is ideally placed to make the most of this growth, as we hunt for high-quality businesses, with strong moats and long runways for growth. We remain optimistic about the outlook for emerging markets and believe the conditions are ripe for EM to significantly outperform developed markets from here.

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.

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