Is it time for investors to reassess emerging markets?

Emerging markets, ordinarily seen as a hive of opportunity, have slipped off many investors’ radars due to several factors, including China’s well-documented property crisis and concerns over far tighter US monetary policy which has bolstered the attraction of cash. 

However, better market returns, an improving economic backdrop and the prospect of lower US interest rates suggest now might be the time to reassess their potential.

There is a myriad of reasons to consider emerging markets from a long-term perspective, including numerous economic and demographic advantages – they are the chief drivers of overall global growth, accounting for 50.1% of global GDP in 2023, and 66.7% of global GDP growth in the prior decade.¹

They are also enjoying rapid industrialisation, house most of the world’s population, have a young workforce - more than 40% of India’s population is under the age of 25 - and enjoy a rapidly growing middle class.²  One analysis estimates that by 2030, most emerging market consumers, at 75%, will be between the ages of 15 and 34 – and will be more optimistic about the economy and willing to spend.³

Tighter policy

Investing in the world’s developing economies has always been synonymous with the high-risk, high-reward mantra.

The more typical problems associated with them include political – and often geopolitical instability, lax regulation, and a lack of transparency in company information, compared to developed markets.

More recently, geopolitical risks and certainly the aggressive rise in US interest rates have hurt developing economies - a stronger greenback has upped debt levels while lacklustre global economic growth has also taken its toll.

Turning a corner

However, one clear sign of a potential rebound for emerging markets following years in the doldrums is that investment returns have recently been relatively closer to those of developed markets. The JP Morgan Emerging Markets External Sovereign Bond index is up 4% year to date while the MSCI Emerging Markets index has delivered a total return of 9% over the period. Over the same period, the MSCI World is ahead by 12% while the ICE BofA Global Government Bond index is flat for the period.⁴

From a wider perspective, there have been some positive developments which have bolstered emerging markets’ more recent success.

For example, economic growth has been resilient despite the weakness of China. The International Monetary Fund (IMF) expects emerging market and developing economies to now grow by 4.3% in both 2024 and 2025, up from previous estimates of 4.2% - with the upward revision down to “stronger activity in Asia, particularly China and India”.⁵

Companies in countries like India, China, Indonesia, Mexico and Saudi Arabia tend to enjoy increased revenues when developed market growth is strong. This not only has positive effects on these countries’ domestic economies but also provides support for direct investment into their equity and corporate bond assets.

The IMF found that in 2023, net capital flows into emerging markets, excluding China, recovered from a post-pandemic low to US$110bn, or 0.6% of GDP in 2023 – the highest level since 2018.⁶

Megatrend adoption

Megatrends such as decarbonisation, technological innovation and the growth of artificial intelligence (AI) are also helping drive growth.

In China, for example, between 2021 and 2022 electrical vehicle (EV) sales jumped from 1.3 million to 6.8 million – representing more than a third of the world’s EV sales in 2022⁷ .

Metals like copper and nickel - key components in clean energy and EV infrastructure - are likely to be in higher demand as the world moves towards net zero. More than a third of global copper production comes from Chile and Peru while Indonesia, the Philippines and Russia account for two-thirds of nickel production.⁸

Equally the adoption of AI will help up productivity and drive transformation across a wide spread of industries across emerging markets.

Financial fortification

Emerging markets have in general weathered the global monetary tightening. Much of this is because countries have taken steps to fortify and reform their financial institutions and are benefiting from stronger policies and financial frameworks, notably in Argentina, Egypt, Ghana and Pakistan.

Credit rating agency upgrades by the likes of S&P Global and Fitch have been more numerous than downgrades in recent months. This reflects the better global macroeconomic picture as well as the success of restructuring programmes, often implemented under the auspices of the IMF. 

The beginning of an easing cycle in the US should help emerging markets too - it should reduce dollar strength, which provides more flexibility for central banks to pursue easier policies in emerging markets while lower US interest rates will raise the attractiveness of potential emerging market returns.

And to that point, the MSCI Emerging Market index has a valuation closer to the more fair-value indices of Europe, than to say the technology-heavy US market indices and the current consensus forecast among equity analysts is for earnings growth of 18% over the next 12 months.⁹

Challenges remain

Several emerging countries have already held elections this year – including India, South Africa and Mexico. So far this has not generated too much in terms of new policy directions but the US election will be key for emerging markets, given that a second Donald Trump presidency could again favour protectionist trade policies. These would likely be aimed mostly at China but could have spillover effects through supply chains to other Asian countries.

Geopolitical tensions could intensify more widely given the situation with China and Taiwan and in the Middle East.

Financial fragility remains an issue too, particularly in sub-Saharan Africa and in Latin America. Climate change risks pose a long-term threat too with the potential for disruption to agriculture, trade and communities.

However, emerging markets economies represent a much larger part of the global economy – and this is a trend which will only continue, certainly in the wake of developments in decarbonisation and technology.

Right now, a plethora of value can be found and given the less-than-stellar run the sector has endured of late, emerging markets could now represent a potentially solid, long-term investment opportunity.