Going forward: What China means for emerging markets (and beyond)

abrdn’s Tom Harvey and guest Devan Kaloo cover all things emerging markets on the latest podcast episode; looking back on Q3 while looking ahead, particularly at Chinese domestic stocks, artificial intelligence, oil prices, and higher-for-longer interest rates.

Transcript

Tom Harvey: Hello, everyone. This is Tom Harvey from abrdn, and you're listening to the Emerging Markets Equity Quarterly podcast, the show that looks at what happened in the most recent quarter and provides our outlook for the asset class. Today, I'm joined by my colleague Devan Kaloo, Head of Global Emerging Markets. Devan, welcome to the podcast. It's great to have you on today.

 Devan Kaloo: Great, thank you. 

 Tom: I think we'll start with a little bit of what we've seen. Markets have certainly been perhaps quite turbulent, quite volatile in the most recent quarter. So, if you could just walk us through a little bit about what we've seen in emerging markets. 

 Devan: I think it's a really interesting quarter because we seem to have made this major transition from thinking that it’s a Goldilocks scenario out there to one where people are concerned about the higher-for-longer and that sense of obligations for assets, and emerging markets have been no exception. So, over the quarter, emerging markets were down almost 300 basis points. Actually, that's pretty much in line with, I think, the US markets and I suppose two elements here. One, on the back of the higher-for-longer rate expectations we've seen some of the growth stocks selling off. So, that initial enthusiasm we saw in AI companies, in particular, or tech companies in particular, some of that has lost steam towards the latter end of the third quarter. But actually the other big feature which has impacted markets, of course, has been the rise, the quite incredible rise in the oil price - 27%, 28% in just one quarter. So, I think those are probably the two big things which have been the headlines for all asset classes. Specific to emerging markets, there's been the ‘is it, or isn't it?’recovering China story. And certainly when we look at some of the underlying data, the mood music, certainly in terms of investors, foreign ownership of China has collapsed over the last 12 months. The mood music is not great. But if you dig a little deeper, we actually think there are some green shoots appearing. 

 Tom: And so, what has this meant for abrdn strategies?

 Devan: Well, certainly not goods, insomuch as the two areas which have been a detractor to us have been our continued skew in the portfolio towards Chinese domestic consumption plays, China domestic stocks, full stop. So, that issue with regard to foreign sentiment in particular towards China has been particularly troubling insomuch as many of what we would consider really high quality companies have been sold off by foreigners who look to exit the market or reduce their position significantly. That's been on one side. On the second side, when looking at some of our tech positions, they certainly have also struggled a little with regard to the sell off that we’ve seen more recently in the tech names on the back of the higher-for-longer. So that sense, when we look at the portfolio, as I said, emerging markets were circa down about 300 basis points. We would have been anywhere between 150 -180 basis points behind that. But I do think that one of the really interesting things here is that the outlook for emerging markets for the next quarter and going into 2024 looks much more robust. 

 Tom: Well, that's the perfect segue into what you might expect as we round out this year. But I think also important for investors, you know, the end of the year is coming up and asset allocators thinking about where they want to be in 2024. So, maybe you can discuss a little bit of that shorter term outlook, but then perhaps what we see for emerging markets as we move past 2023?

 Devan: Yeah, I suppose when people are thinking about emerging markets at the moment all they're thinking about is that you have this weak China, that potentially may get worse on the back of a property market unwinding. You have the issue of a stronger dollar because if you have interest rates in the US remaining higher-for-longer, or indeed going higher, that is certainly dollar supporting. And then the third thing of course, is that you potentially have the impact of oil prices being higher, which impacts some countries in some areas negatively in terms of lifting up inflation and as a result of that, perhaps meaning that in many countries interest rates don't come down as much as we had hoped. I think when we think what has happened in the market Q3, a lot of that is in the price. And when we look at going into Q4 and certainly into 2024, what I would say is that we have a Chinese market which is absolutely unloved and under….. And in our opinion, we're starting to see some of that stabilization and growth, and indeed potentially better growth numbers coming through into 2024. And that sets us up nicely for potentially quite a strong move in the Chinese market.

The second thing is that the dollar has already appreciated this year, on the back of the higher-for-longer, and of course one of the big issues that we'll be debating for no doubt some time yet to come is whether or not the US economy slows down significantly in 2024 to allow rates to come down and, as a result of that, the dollar becoming weaker as a consequence. I think that we would probably be in the camp that there is a consequence to higher rates, particularly in highly intensive economies like the US, so we would see that dollar weakness coming through towards the latter part of 2024 which would be positive for EM. And the final point is that we do think that when we look at some of the tech names, in particular tech hardware names, there is quite clear earnings drivers in ‘24, ‘25 going forward and, as a result, some of these valuations look pretty compelling.  But if I could broaden that out just slightly, I do think there is a really strong CapEx story still coming through for emerging markets on the back of supply chains being shifted as a result of people derisking China exposure. The second is on the tech cycle recovery, which we think is partly AI but broader than that. And then the third thing is that we do see continued investments into transition to a greener economy and that is of benefit to emerging markets. So, from a bottom up perspective, I think valuations are cheap, I can see some earnings tailwinds. And I suppose the big question, which is uncertain and much debated, is what happens with the US economy, US interest rates and as a result, the US dollar. 

 Tom:  Thank you, Devan. I'm going to pose perhaps just a question or two here, if that's okay? China, obviously, especially here in the United States, a big concern for investors. How are you thinking about China from an allocation standpoint within emerging markets or from a portfolio standpoint? 

 Devan: Well, I think it's a difficult one to manage because China, in absolute terms, is quite a large component of emerging markets - so it's circa 30% - and I think, certainly in terms of owning a diversified portfolio, being much more than that is something that we would be a little gun shy of doing. Primarily because there are a number of headwinds to China longer term in terms of demographics, in terms of perhaps the tension between China and the West, and the US. But balancing that out on the other side, which is why we're quite positive, is the valuations look extremely cheap. And we do believe that the government is doing enough and doing, we expect to do more in terms of supporting the underlying domestic economy and therefore, as a result, we're still pretty convinced that the domestic stocks are oversold and certainly their earnings profile going into 2024 will be better.

And the result of that is an overweight within the portfolio to domestic stocks in China, but neutral broadly against China overall as a market.

 Tom: Great. Devan, thank you very much. That feels like a pretty good place to bring this podcast to a close. Thank you, Devan, very much for joining today. 

 Devan: Thank you. 

 Tom: And thanks everyone who took the time to listen in today. If you enjoyed this podcast, please download our other podcast from our website or wherever you'd normally get your podcasts.