Weekly Buzz: An emerging trend you might have missed

28 July 2023

With all the excitement this year surrounding Big Tech (here’s our take on it), there’s another trend that might have slipped under the radar. But it seems the spotlight is now starting to pivot back onto emerging markets (EM). Let’s take a look at the trend that’s emerging.

What’s going on with EMs?

  • EM economies are growing fast

The International Monetary Fund (IMF) forecasts that emerging economies will grow by an average of 4.2% in 2024, compared to 1.4% for developed economies – the widest growth differential in a decade. The IMF also predicts that China and India will be the top contributors to global growth in 2023, together responsible for a staggering 50.4% of total world growth.

  • EM stocks are cheap

When it comes to investing, it’s always important to consider valuation. The cyclically adjusted price-to-earnings (CAPE) ratio (our Jargon Buster below breaks this down) is used here to paint a long-term picture of valuation. Based on this metric, the emerging world as a whole is almost twice as cheap as the developed world, with EM stocks trading at a CAPE ratio of 15.1x versus 27.9x for their developed peers. This owes largely to the very cheap China (with a CAPE ratio of 10.9x) and the very expensive US (with a CAPE ratio of 33.8x).

  • EM currencies are strengthening

Five of the world’s top eight performing currencies against the USD this year have been Latin American EMs (see the graph below), off the back of higher yields. And with cooling inflation, bets are that the Federal Reserve (the Fed) will stop hiking interest rates, which would send the value of the greenback lower. Strengthening EM currencies mean increasing returns for international investors, when gains are converted back into their home currency.

What’s the takeaway here?

EMs may just be taking back the spotlight soon. Recent poorer performance in EMs can be attributed to the impact of China, which has faltered in its recovery. The chart below shows how much better EMs (black line) would have performed, if you exclude China (blue line). The index still lags behind global stocks (grey line), but by a thinner margin.

But there are also broader risks – a slowdown in the developed world would test just how much EM economies have managed to decouple from their more developed peers. Meanwhile, China’s slow recovery could dent growth in the EMs that are reliant on it.

So it may be better to take a balanced approach to EM assets, which tend to be more volatile. For diversified exposures to both developed and emerging markets, consider staying invested with our General Investing portfolios. And if you’re looking for more control over your investment strategy, our Flexible portfolios let you custom-tailor your own asset allocations.

This article was written in collaboration with Finimize.

🎓 Jargon Buster: CAPE ratio

Despite its complex name, the cyclically adjusted price-to-earnings ratio, or CAPE ratio, has a simple purpose. Like its cousin, the P/E ratio, the CAPE ratio shows how much investors are willing to pay for a company's earnings – but takes it a step further, instead using average earnings over the past ten years. This smooths out the ups and downs of business cycles.

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