Emerging-market equities have performed well in 2024, returning 9.6% between January and August and 5.9% in the three months ended August 31. South Korea and Taiwan were buoyed by the Information Technology sector, while markets in China and Brazil held back returns given concerns about slowing economic growth. Consumer Staples was the worst performing sector. In our view, the outlook for emerging-market equities is likely to be shaped by four factors: the performance of stocks related to artificial intelligence (AI); the U.S. elections in November; movements in the U.S. dollar and interest rates; and China’s economic performance. Emerging-market stocks are supported in the longer term by attractive valuations outside of technology stocks as well as faster economic growth than is usually available in developed markets.
The Information Technology sector, particularly stocks with exposure to AI, has been on a tear over the past 18 months and contributed disproportionately to the performance of emerging-market equities. Even with a recent pullback, the magnitude of the gains and the sector’s valuations remain fairly extreme. Since the start of 2023, Taiwanese equities have rallied significantly, led by chipmaker Taiwan Semiconductor Manufacturing. In South Korea, SK Hynix, the main supplier of memory chips for Nvidia’s AI-powering processing units, is also up meaningfully. Nvidia itself has risen nine-fold over the same timeframe. Needless to say, valuations have become elevated in historical terms. Most of the AI supply chain is in Taiwan, where about 80% of the exchange’s market capitalization is related to technology. Exhibit 1 shows the MSCI Taiwan Index’s long-term price to book value relative to the broader MSCI Emerging Markets Index and offers an illustration of how stretched valuations have become in this area of the market.
Exhibit 1: MSCI Taiwan vs MSCI Emerging Markets 12-mount forward PBV
Emerging markets – Recommended sector weights
The 2024 U.S. election, set to take place on November 5, is almost certain to influence emerging-market equities. Polls and betting markets indicate a close race between the Republican candidate, former President Donald Trump, and Democrat Kamala Harris, the current vice president.
Regardless of which candidate wins, relations between the U.S. and China are likely to remain fraught, albeit for different policy reasons. We would expect Trump to concentrate on using tariffs to reduce the U.S. current-account deficit, while Harris, like President Joe Biden, would likely extend restrictions on technology transfers to China. Our view is that Trump is more concerned with negotiating agreements and less ideological, and that his approach may be simpler for China to live with. Trump reached a trade deal with China in January 2020, and the hope would be that he would be willing to negotiate if elected.
The aim of a Democratic administration under Harris would be to curtail China’s technological development to protect U.S. military and economic superiority, and we could therefore expect more restrictions on technology to close loopholes. Restrictions could be extended to include the previous generation of Nvidia’s graphics-processing units, or in terms of geographical reach, to include Southeast Asian countries where Chinese internet companies are developing data centres. Outside China, however, we would not anticipate a significant departure from the current administration's stance. Given a more predictable policy path, a Harris victory could reduce the potential for financial-market volatility. While Trump’s proposals for a general 10% tariff and one of 60% on Chinese goods sound harsh, it’s far from certain he would follow through in light of the potentially negative impact they could have on global trade. Moreover, such restrictions would conflict with his stated objective of weakening the U.S. dollar.
The direction of the U.S. dollar remains a critical influence for emerging-market returns. While the U.S. dollar’s modest weakness over the past two months has eroded some of the greenback’s decade-long strength, dollar valuations remain extended, and emerging markets as a group tend to have healthier current accounts and fiscal positions. Our view is that the U.S. dollar is likely to weaken over the longer term, boding well for emerging-market equities.
MSCI Emerging Markets Index Equilibrium Normalized earnings and valuations
Chinese equities continue to hold back the performance of emerging-market stocks given the country’s less than robust economy. We believe, however, that the trend could reverse as earnings have been resilient and investors' widespread negativity toward China means that foreign investors are now under-represented and valuations therefore alluring.
Moreover, government spending has increased in 2024, helping to stabilize the economy and lay the groundwork for accelerating GDP growth. Chinese officials recommitted at recent high-level Communist Party gatherings to the goal of 5% real GDP growth in 2024, implying an acceleration in the economic expansion during the second half of this year. Officials have made boosting consumption a high priority for the remainder of 2024 and to that end have extended programs that encourage consumers to buy autos and appliances while also raising hopes for measures supporting service industries. In sum, Chinese equities have the potential to rebound if a recovery in economic growth materializes given record-low valuations and investor positioning.
Returns in emerging-market equities have tended over the past 35 years to excel in relative terms when earnings and GDP in emerging markets increases faster than in developed markets, and vice versa. This relationship broke down in 2023, as relatively fast emerging-market growth did not lead to equity-market outperformance. One reason for this breakdown was likely that the influence of AI-related stocks in developed markets, particularly the U.S., had an outsized impact on index returns. We would expect the relationship between emerging-market and developed-market equities to re-establish itself in the coming years as market compositions return to a more “normal” state.