Latest Emerging Markets (Unconstrained) economic and market outlook.
We have been concerned about China for some time due to the mishandling of the property crisis, the insistence on sticking with a draconian zero-Covid policy, and elevated geopolitical tensions potentially leading to a lower export market share and less Western capital flowing to China. Unfortunately, the recent Chinese Communist Party National Congress has accentuated all of these concerns. It represents a watershed moment – politically as well as economically – in terms of moving on to the next phase of Xi’s policy agenda, namely a gradual realisation of the goal of “common prosperity” and a more insular model for future economic growth. Security and self-sufficiency will now rank above all other priorities, including economic growth. All newly appointed members of the Politburo Standing Committee are committed Xi loyalists. This composition makes for the most uniform Politburo of the last four decades, with all members owing their political accession to Xi. As a result, the world’s second-largest economy is now effectively under one-man rule. By removing all dissenting voices, China has no balance of power within its governance systems, resulting in a growing risk of geopolitical or economic policy errors.
Despite the rising political risk, there will undoubtedly be winners from China’s new policy priorities. The portfolio has therefore been shifted towards opportunities in the environmental, technological, medical and manufacturing supply chain sectors, all of which should be key beneficiaries.
All things equal, elevated geopolitical tensions between China and the West should be a positive for many of the portfolio’s holdings as our significant exposures include Korea and Mexico. The more the West looks to decouple from China, the more reliant it will be on Korea for its semiconductors and EV battery materials, and Mexico for its manufacturing.
Turning to Brazil, the outcome of the election is a reasonably positive one in our view. Although there are still some doubts about Lula’s ultimate policy direction, the centre controls both chambers, meaning Lula will need to find majorities to push through his agenda. This should prevent him from steering too far to the left. That said, for the market to move much higher from here, it will be important to get visibility on the rest of Lula’s team, most notably the Minister of Finance. There is speculation that it could be either a moderate that is well regarded by the market, or a politician. The latter would be taken negatively by investors. An announcement is expected to be made in the coming weeks. From an economic perspective, Brazil has a currency that still looks attractively valued, as well as elevated real rates. Brazil should be one of the first countries to begin an easing cycle, most likely in the first half of next year. We own companies that should benefit from a lower rate environment such as Eletrobras, which also has a big opportunity to restructure and cut costs following its privatisation.
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