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Niall Paul

Market Outlook

Emerging Markets (Core) Outlook

Outlook
12 March 2023

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Emerging Markets and Non-US Portfolio Manager

Latest Emerging Markets (Core) economic and market outlook. 

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We remain constructive on EM equities for several reasons. Firstly, for some time they have faced a significant headwind in the form of a sharply stronger dollar, but our view is that such currency appreciation is now largely behind us, with the Fed inching closer to the end of its tightening cycle. A more stable dollar would allow EMs in aggregate to outperform. Secondly, the inflation outlook is very different for EM than in the West. There are of course EMs with high inflation, but their central banks have been very hawkish. For example, Brazil has an overnight lending rate of 13.75%. Inflation has fallen from 12% to 6% since May, leaving real rates at almost 8%. This stands in sharp contrast to the West, where many countries still have negative real rates. Moreover, much of the EM universe is not seeing problems with inflation; if anything China continues to face some deflationary pressure. Finally, we believe that earnings expectations in much of the developed world are too high, and expect downgrades over the course of the year. Conversely, we expect earnings upgrades in EM this year, driven in part by the rapid Chinese reopening, which should drive pent-up spending. On a relative basis we therefore see EM equities as very attractive at this juncture.

The portfolio’s current key thematic exposures are as follows. Firstly, we own cyclicals that are already pricing in a potential recession by being close to trough multiples. Examples include semiconductors and gold. Secondly, we have exposure to areas of structural growth with the added tailwind of governmental fiscal support. The most notable example is renewables. Developments over the past year should lead to a structural acceleration in growth for green tech companies, be it higher energy prices and the quest for energy security in the wake of the Ukraine invasion, or seismic policy pivots represented by the US Inflation Reduction Act and REPowerEU. Thirdly, we own free cash flow/earnings inflection names in Growth sectors. For example, the Chinese Internet platforms have undertaken significant cost cutting programmes, so should have high operating leverage as Chinese growth begins to reaccelerate. Fourthly, we are overweight Brazilian beneficiaries of falling rates, including XP, Lojas Renner and Eletrobras. As discussed above, we expect easing to take place in Brazil given elevated real rates. Finally, although underweight India generally due to rich valuations in certain sectors, we remain overweight Indian banks as we believe they are in the top-down/bottom-up sweet spot.

It is worth touching on India in more detail as we have just returned from a research trip there. We expect to see a marked pickup in the investment cycle, which should lead to an acceleration in economic growth due to the multiplier effect of investment. This conclusion is based on a number of observations from our recent research visit. Firstly, the banking system is well capitalised and profitable. It is therefore able to fund an investment cycle. The corporate sector is also profitable and cash generative, and is seeing rising capacity utilisation. Thus, it appears to have the means and motivation to invest. Moreover, the recent Budget was extremely supportive of infrastructure, and we expect the government will continue to prioritise infrastructure investment as major headwinds to higher infrastructure spending have eased in recent years. In fact, we expect infrastructure capex in India to grow at a 9-11% CAGR over the next few years, driven by the National Infrastructure Pipeline, which envisages >US$1.3tn of capex for FY20-25 versus c.US$700m over FY13-19. Meanwhile, the government’s support for private capex should continue. The Production Linked Incentive scheme is a key component of the Make in India initiative to boost manufacturing output from 17% of GDP to 25% of GDP by 2030. It is widely deemed to have been a success and will likely be expanded. At the same, India is enjoying record Foreign Direct Investment inflows, with Apple’s decision to shift a significant proportion of its iPhone production to India just one high profile example of this. Finally, we believe that the property cycle will also be supportive, particularly given the country’s focus on affordable housing. 

Important Information:

Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).

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