- Emerging markets (EM) saw broadly positive returns across most countries and sectors.
- Most severe style rotation in EM history has continued in 2023, hurting growth stocks.
- Chinese equities have lagged the broader asset class.
- Technology, especially the semiconductor industry, rallied on strong earnings guidance and the demand outlook for artificial intelligence (AI), leading to sector outperformance in 2023.
- The strategy underperformed its benchmark due to our Chinese holdings significantly lagging the market and broader asset class.
- We expect the market to reward high quality growth stocks as markets anticipate a slower global economic growth environment – EM ex-China already showing a significant pickup in sentiment and performance.
2023 began positively with a clear improvement in both sentiment and performance across emerging markets. Although concerns persisted throughout the period around rising inflation, interest rate hikes and economic and political policy, MSCI index heavyweights ended the year also in positive territory. The notable exception to this was China, the largest country constituent of the index (chart 1). Although we began to see improvement in this market early in the year, it was marred by further concerns around a slowdown in economic recovery in the domestic market. This was fuelled by disappointing economic data and increased regulation against Chinese companies from the US as the year progressed. The negative sentiment has persisted into the end of the year.
Chart 1. Performance of China and ex-China segments of MSCI Emerging Markets in 2023
Source: MSCI, 31 December 2023. Data in US$.
There is continued divergence between Growth and Value investment styles in emerging markets. This has favoured lower duration, value stocks over higher quality, growth-oriented stocks. It has also led to valuations being depressed for these types of stocks, dislocated from company fundamentals which, on the whole, remain robust. Although the short term has therefore been difficult for emerging market managers with a quality-growth tilt, like Martin Currie. We view the current scenario as an opportunity to enter the market at a very competitive valuation for businesses with sustainable growth trajectories and high quality characteristics. To help put this recent period into context, it is the largest style rotation in EM history (chart 2), exacerbated by both the interest rate environment and by the selloff in the Chinese market.
Chart 2. Three years rolling return gap between MSCI EM Growth and MSCI EM Value Indices
Source: Morningstar, 31 December 2023. Performance of the MSCI EM Growth and EM Value indices shown in US$.
In terms of sectors, information technology and energy were the strong within the asset class, with real estate lagging the remaining sectors. Technology stocks have seen strength this year upon renewed optimism about inventories, supply/demand dynamics and an interest in artificial intelligence. This was particularly beneficial for semiconductor and related industries. Energy stocks have been buoyed by high oil prices this year, with many “high polluters” outperforming the market. In relative terms, while our underweight exposure to more “polluting” stocks detracted, our portfolio benefitted strongly from the rally in technology (chart 3). We allocation almost a third of the strategy portfolio to this sector and it is our largest overweight (we are overweight the sector). We believe that we have a balanced exposure to some of the best IT opportunities in EM across memory, foundry, semiconductor materials, electrical components and IT services industries.
Chart 3. Sector Contribution to Returns 2023
Source: Martin Currie, 31 December 2023. Data shown for the Martin Currie Global Emerging Markets representative account against the MSCI Emerging Markets Index.
At the country level within emerging markets, the “tail markets” did exceptionally well. These markets are small weights in the benchmark but had absolute performance that was significantly above benchmark. They total represent nearly 2.0% of the MSCI Emerging Market Index allocation: Hungary, Poland, Greece, Peru, Egypt, Czech Republic. In terms of our portfolio, we are underweight these countries, and so this was a relative drag on performance. Stronger performance in technology-driven economies such as Korea were additive.
China was the key detractor from the portfolio’s return relative to MSCI Emerging Markets, and here there were a few key factors at play. The macro and political environment was not supportive of equity markets and sentiment was consistently negative, exacerbated by the style rotation away from growth and towards low quality value stocks. This is reflected in the realised share price performance of our holdings. Despite having a broadly diversified Chinese book covering renewables, healthcare, financials and the digital economy, we witnessed a broad derating of between 10-60% across our holdings. In the same year, the majority of these delivered earnings growth and all of them have projected positive earnings growth in 2024 (based on consensus estimates)1. There has been a dislocation between the operational performance of these companies and what the market is willing to pay for them. We have conviction in the robustness of our holdings and we believe that the market will recognise it, and valuations will edge nearer to fundamentals in 2024. This presents opportunities with significant upside in China.
We are at a unique juncture as we enter 2024, where all five points of fundamentals, valuation, positioning, politics and policy are in positive alignment. This is a powerful combination and we believe it places EM companies and countries in a strong position. They are set to benefit from strong earnings growth, attractive valuation, a supportive fiscal and political environment and the prospect of a potential normalisation in global/EM asset allocations. We are excited as we enter 2024 to see how companies and the market respond to this favourable environment. We have produced a detailed outlook for 2024 which is available on our website – we encourage you to read this. Below we highlight three key points for why the outlook is bright for the year ahead.
- i) The return of EM growth stocks:
In an environment of slowing global economic growth and peaking interest rates, growth stocks are well placed to lead the way in 2024. US growth stocks have already begun outperforming, but EM growth stocks have yet to play catch up. In fact, value has now outperformed growth in EM for three consecutive years. We believe this has created attractive valuations for EM growth stocks heading into 2024.
- ii) China – misconceptions create opportunities:
A key drag on EM returns has been the performance of the Chinese market. We feel there are significant misconceptions about China, which in turn is driving material disconnects between share prices and fundamentals. We see signs of geopolitical repair and more domestic shareholder-friendly messaging around private businesses in the country. Accordingly, we think investors will begin to reassess their increasingly cautious approach to China amidst this unprecedented divergence between share prices and fundamentals.
- iii) Structural opportunities – technology and India:
Over the long term, technology has been the best performing sector in EM and represents around a fifth of the MSCI Emerging Market Index. We believe the sector remains a fantastic long-term opportunity. Despite narratives around onshoring, the reality is that the global technology supply chain continues to be heavily reliant on companies within EM countries. These companies are essential for the advancement of global technology, providing investors with a diverse range of opportunities, and are trading at materially lower valuations than US peers.
We believe India is the greatest economic opportunity globally. Seizing its demographic dividend, its time has come. Importantly, there is a rich opportunity set within the country given the presence of companies with long-term structural growth potential and well-regarded management teams. These range from luxury retailers harnessing the power of technology in a market historically reliant on in-person service to retail and corporate banks reaching historically underpenetrated parts of the market using technology and innovative business practices, or global industry-leading materials companies driving positive change in an environmentally lagging sector. We expect these types of companies to continue to ride the wave of the Indian economic opportunity.
1 Source: Martin Currie, Bloomberg and FactSet, January 2024.
The information provided should not be considered a recommendation to purchase or sell any particular strategy / fund / security. It should not be assumed that any of the security transactions discussed here were or will prove to be profitable.
This information is issued and approved by Martin Currie Investment Management Limited (‘MCIM’), authorised and regulated by the Financial Conduct Authority. It does not constitute investment advice. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.
The information contained in this document has been compiled with considerable care to ensure its accuracy. However, no representation or warranty, express or implied, is made to its accuracy or completeness. Martin Currie has procured any research or analysis contained in this document for its own use. It is provided to you only incidentally and any opinions expressed are subject to change without notice.
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Some of the information provided in this document has been compiled using data from a representative account. This account has been chosen on the basis it is an existing account managed by Martin Currie, within the strategy referred to in this document. Representative accounts for each strategy have been chosen on the basis that they are the longest running account for the strategy. This data has been provided as an illustration only, the figures should not be relied upon as an indication of future performance. The data provided for this account may be different to other accounts following the same strategy. The information should not be considered as comprehensive and additional information and disclosure should be sought.
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Risk warnings – Investors should also be aware of the following risk factors which may be applicable to the strategy shown in this document.
- Investing in foreign markets introduces a risk where adverse movements in currency exchange rates could result in a decrease in the value of your investment.
- This strategy may hold a limited number of investments. If one of these investments falls in value this can have a greater impact on the strategy’s value than if it held a larger number of investments.
- Smaller companies may be riskier and their shares may be less liquid than larger companies, meaning that their share price may be more volatile.
- Emerging markets or less developed countries may face more political, economic or structural challenges than developed countries. Accordingly, investment in emerging markets is generally characterised by higher levels of risk than investment in fully developed markets.
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