Market Commentary

The Stars Are Aligning for Emerging Markets

By Rob Sigler, MBA

September 26, 2024

One of the more interesting observations that we have witnessed lately is the continued disdain for Emerging Markets (EM) equities and debt.  According to Lazard Asset Management, Emerging Markets remain an under-owned asset class.  Their work concludes that a mean reversion to the 20-year average asset allocation weighting would represent inflows of $910 billion into the asset class.  For context, that equates to roughly 58% of current EM assets under management.

Why the disconnect from historical asset allocation patters?  Investors often suffer from a cognitive bias that favors recent events over historic ones.  We call that Recency Bias.  In this situation, EM has underperformed for years in a row, there has been significant geopolitical risk, and finally, the largest emerging market in the world, China, has been embroiled in a property bust akin to what the United States experienced in 2007-08.  However, there are reasons for optimism.

What will be the catalyst to propel outperformance and nudge investors to devote more capital to the asset class?  First, EM economic growth in 2024, as measured by GDP is up 4.2% YTD while developed markets have seen growth slow to 1.5%.  Earnings are following suit.  Consensus forecasts have EM growing 17% in 2024 and 15% in 2025, as compared to the United States at 11% and 14%, respectively.  Meanwhile, valuations of EM equities reside at 12.6x compared to 18.7x for developed markets, and 21.7x for the United States.  Additionally, we are finally entering into a period of Federal Reserve interest rate easing.  Historically, this provides cover for emerging markets to follow suit, and incidentally, we are already seeing it.  Finally, China is starting to recover.  The charts below, courtesy of Carlyle, show that Chinese real estate sales appear to bouncing off the lows, coincident with housing pricing finding its bottom.  And by the way, that was observed before China’s central bank unveiled a major package of measures aimed at reinvigorating the country’s economy on Tuesday.  The list is lengthy, but it included reductions to mortgage rates, lower minimum down payments for real estate purchases, and loans by the central bank to fund local governments’ purchase of unsold real estate.

 

Our bottom line is that the catalysts are lining up and yet investors are strangely indifferent.  We think this will be a powerful revaluation story and we intend to capture it for our clients.

About the Author