Despite China's economic challenges, experts believe it still has a role to play in the EM space
The global financial landscape has been dominated by U.S. equities for the past several years but after a decade of underperformance, emerging markets may be set for a resurgence.
Arup Datta, senior vice president and head of Mackenzie’s global quantitative equity team, Sammy Suzuki, head of emerging markets equities at AllianceBernstein and Andrew Ness, portfolio manager at Franklin Templeton Emerging Markets Equity, are all increasingly optimistic about the future of EM, particularly in key markets like China, India, and Taiwan.
Datta acknowledges that China remains a central player in the EM space despite its recent economic challenges. The country, which still represents the largest market in the MSCI EM Index, hovering around 22 per cent, is grappling a problematic real estate sector and a slowing economy. However, he argues that these concerns are already reflected in the current valuations, making China an attractive investment.
China’s market is trading at around “10 times earnings”, Datta highlighted, a significant “discount” compared to historical averages and other global markets. While some investors draw parallels between China's current situation and Japan's economic stagnation in the 1990s, he dismisses these comparisons, particularly on valuation grounds. He asserts that China presents a compelling opportunity for contrarian investors, especially given the negative sentiment among Western investors.
“There could be some similarity, but valuation wise, there's no similarity,” Datta says. “A Japanese market [in the 90s] was many times higher priced than China today. That's why I would say China is basically a valuation call.”
Suzuki echoes this sentiment, pointing out that “China is the second largest economy in the world” and is home to over 600 companies alone within the MSCI EM Index. Even in a "lukewarm" economic environment, as Suzuki puts it, “there are stock selection opportunities, even within China, that are likely constructive.” Additionally, the country’s negative sentiment and low expectations could set the stage for a potential market rebound, driven by selective investments in well-positioned companies.
India and Taiwan are emerging as bright spots within the EM landscape, with both countries contributing significantly to the MSCI EM Index, 19.3 per cent and 18.9 per cent*, respectively. Datta and Suzuki agree that these markets have not only kept pace with the U.S. over the past decade but are well-positioned for continued growth.
India, now the most populous nation in the world, has seen robust earnings growth and has largely stayed out of geopolitical conflicts, adding to its attractiveness as an investment destination. Datta highlights the pro-economic stance of Prime Minister Narendra Modi, noting that despite political challenges, the Indian economy continues to perform well. However, Suzuki cautions that the high consensus around India’s potential has led to elevated valuations, which could pose a challenge moving forward.
The bullish India outlook is not new, though it seems to be gathering pace. In a widely quoted report from 2022, Morgan Stanley declared that India will likely have the third largest stock market by the end of this decade, surpassing Hong Kong and Japan. Accordingly, Morgan Stanley’s chief equity strategist for India, Ridham Desai, at the time said that the country’s rise is “a once-in-a-generation shift and an opportunity for investors and companies.”
Taiwan is a hub of technological innovation, particularly in the semiconductor industry. The semiconductor segment, which is key for technology-centric markets such as Taiwan and South Korea, is experiencing a strong recovery, largely driven by demand for AI servers, notes Andrew Ness, portfolio manager at Franklin Templeton Emerging Markets Equity.
“Another key driver for semiconductor-related growth is the segment’s contribution to climate stability through the usage of semiconductors in energy-efficient solutions. Conversely, growth expectations of the electric vehicle segment have been lowered materially, and we expect earnings to be impacted in the short term,” he says.
The emergence of artificial intelligence (AI) has also been a big catalyst for EM in Taiwan, Ness added, as “many of the semiconductor and hardware companies catering to the AI industry are based here and are key suppliers of chips and tools which helps enable the AI revolution. AI has seen a boom led by the development of large language models which has been facilitated by the advancement in semiconductor chips.”
Datta points to Taiwan Semiconductor Manufacturing Company (TSMC) as a key player in the global tech sector, benefiting from the growing global demand for AI-related technologies. “Taiwan is a big tech player,” he says. “I'll make the case Taiwan benefits from the innovations in the world. If the innovations in the world continue, Taiwan will do well.”
South Korea is another market to watch, assert Datta and Suzuki. Historically, South Korea has traded “at a discount” compared to other EMs due to complex corporate governance structures. However, Datta and Suzuki believe they're following Japan's footsteps in corporate governance reform.
“The Japanese, led by some of the largest allocators, have focused a lot on corporate governance for the companies in Japan, which has really bumped up the Japanese market. It's gone up a lot in the last couple of years. Korea may play that playbook two years later so that may unwind the Korean discount valuation,” says Datta.
Additionally, Suzuki believes that in South Korea, sectors such as financials, industrials and automotive are set to benefit from the country’s "Value Up" plan, a government initiative aimed at boosting corporate governance and economic competitiveness.
Lastly, Greece, although a smaller part of the EM index, is another market Suzuki finds compelling, comparing it to a “forgotten orphan.”
“It used to be a part of the developed market index, and it was downgraded to EM, but there are a lot of positive changes going on. While it is a small part of the index, even in the emerging markets, there are a lot of positives. There are many good things happening in the EM space,” Suzuki says.
Datta, Ness and Suzuki assert that timing the market is notoriously difficult, but with the current setup, EM could be poised for a decade of growth. While geopolitics and global risk appetite will continue to influence short-term market movements, the long-term fundamentals for many EM countries remain solid.
*At the time of interview
