Emerging markets: China's big bounce

We discuss how after a weak start to 2024, Chinese markets have rebounded as well as other happenings in emerging markets.

Transcript

Tom Harvey

Hello, everyone. I'm Tom Harvey from Abrdn and you're listening to the Emerging Market Equity Quarterly podcast, the show that looks at what happened in the recent quarter and provides our outlook for the asset class. Today, I'm pleased to be joined by my colleague Devan Kaloo, Global Head of Equities. Devin, welcome to the podcast. It's great to have you on.

 Devan Kaloo

Thank you. It's great to be here. 

Tom Harvey

Okay, great. So I think as we think about what we've seen maybe so far this year within emerging markets and then eventually get into what we expect for later this year in 2024, I'd be happy if you could walk us through what we saw from markets during the first quarter. 

Devan Kaloo

Well, as ever with emerging markets, it seems like there's been a lot to talk about. So in Q1, we had a pretty weak start with markets down about 4.6% in January. But the good news is that they subsequently recovered. So they ended the quarter up two and a half percent. But within that, there's been lots of various things and moving parts. So I suppose the key things I would probably highlight first would be that there has been a China bounce, and that's really important because in January the Chinese market was down about 10%, if not slightly more than that. 

And so subsequently in the next couple of months, it was up about nine, 10%. And that was really driven by a couple of things. First, the government coming in. So the government intervened to support the markets in February. The second thing was that we saw more positive economic data coming through from China. And that's really interesting because that's been driven by the strengthening exports and certain segments of the consumer.

But the other really key point here is that we saw inflation coming back into the system. So you may remember that China slipped into deflation last year, which is important because obviously that means that we get some pricing power back for some of the corporates. And on the corporate side, we actually saw some decent results. And in some of the conversations subsequently, many of the companies are actually talking about double digit returns to earnings growth potentially for 2024.

But that bounce is welcome and certainly good for the asset class. The other two things I would just highlight is we saw continued strength in the tech sector, the AI led rally that started last year has broadened out, which is good to see and certainly helped the sector up around 10%. And within that, the tech heavy Taiwanese market was up around two and a half percent.

But it is probably worth just highlighting that there has been some differentiation. So some of the companies, as they were reporting Q4 results indicated that they are facing some supply chain issues and tightness of supply, but also demand perhaps now coming through as quickly as expected. So there has been some differentiation in the tech sector. And the other thing is probably around elections.

So it really is a case of so far so good. We had elections in Taiwan at the beginning of the year, which everyone was very concerned about because, you know, if the wrong candidate won from a Chinese perspective, potentially, that could have prompted some reaction that the candidate won and nothing happened. So that was good to see. And we similarly had an election in Indonesia where the incumbent was, and that certainly bodes well for continuity of some of the good policies that the government has been put in place for a number of years now.

Now, that's some of the big headlines. But of course, in a global picture, what we saw was it wasn't as easy as we would have hoped or expected. And in particular, the strength of the US economy has meant that expectations for US rate cuts has been pushed out and has helped the dollar to be stronger. And that has certainly weighed on some markets, some sectors.

But beyond that we saw a number of really interesting local developments. And let me just delve in a little to this, because I do think it's really important with regard to the markets. The first is that we saw in India, the Indian Reserve Bank, so the central Bank of India tightening liquidity. And this is as a function of the fact that a growth in the economy is very strong.

There is some concerns about inflation and the government said it was their bank has been keen to get ahead of that in terms of tightening things and that had a consequences for some of the financials obviously. But we also seen some moves to try and the strict flows into small and mid-cap funds and that's because we're seeing some bubble like valuations being achieved in some of the sectors.

And this is an area of concern for the Indian government. But these reflect the successes of India and India remains a very strong story. But that liquidity squeeze is something that we should pay attention to. The second, as the carrying value up program. So at the beginning of the year, the Korean regulator and indeed with the back of the government announced that they were keen to take a leaf out of Japan's book and try and encourage companies to boost shareholder returns.

And this is really important in the context of Korea, because something like 70% of the market trades below book so cheap. And part of that is because the low shareholder returns. So there was a lot of interest in that. But of course, one of the things here is they got to deliver on policies that actually support that. And we have an election coming up.

So, the initial rise that we saw in the Korean market perhaps has been slightly tempered more recently by the concerns that the elections are coming, and the new government may prioritize different policies. But that's been quite an interesting feature to look at within the Korean market. So, all in all, it's been a fairly busy quarter and lots more to think about and respond to and plan for in the months ahead.

Tom Harvey

Excellent. Thank you for that, Devan. So, we've seen this, you know, bounce and bounce after a fall in Chinese equities, a full slate of elections. What has this meant for your strategy? 

Devan Kaloo

And I suppose the big issues here really have been India.

India position has cost us circa 100 odd basis points, relative performance. And really two things here is that we were underweight some of these small midcaps, one because of liquidity reasons too, because there was an issue around some of the valuations being asked for. But the bigger impact has been we've been overweight, high quality Indian financials, and that liquidity squeeze obviously has a direct impact on these businesses in so much as means.

A It's difficult for them to perhaps grow loans as quickly as they would have liked or where there was demand and B, it means potentially some liquidity squeeze. So you've seen some earnings revisions downwards for the banking sector and in India. And of course that led to those companies selling off. Our view obviously still remains that this is a good long term story and the liquidity issue will eventually sort itself out.

And I do hasten to add that this is not yet an issue of credit quality. So this is the Indian government, the Reserve Bank, being relatively prudent, but that has been one cost. The second has been the positions that we have in Hong Kong, which is a part of our China positioning more broadly.

So we missed the spark of activity at the beginning of of the year. And in terms of the value up program and that's detracted. But many of our companies trade at or close to or at or above book value. So they're not seen as immediate beneficiaries of this value up program, although the companies continue to do very well in terms of operations.

But that certainly has cost us in the short term, more positively.

And then interestingly, we also saw Peru be a big contributor to the portfolio, we are believers in the outlook for the copper story. And there's been developments over the quarter to suggest that actually supply remains further constrained, whereas demand is picking up and in particular one of the areas where they might see increased demand is around air.

 So much of the air equipment and circuits require increased copper and as a future demand driver for copper going forward. And we've seen the copper buy start to move back up and the copper stocks moving up ahead of that. So that's been a big contributor to the performance as well. So a mixed bag, but disappointing to us to see that was slightly behind.

Tom Harvey

Great Devan, thanks for that. I think this brings us to the portion we kind of look forward and think about the rest of 2024 what we're excited about. What you're expecting. So perhaps if you could touch on that. 

Devan Kaloo

Yes. So we're still pretty constructive on emerging markets.

I think one of the first things probably to address is that we still believe that the U.S. interest rate cycle has peaked and that rates will come down. Obviously, what we've seen to date is a pushing out of the first rate cut. Expectations. But our view is that that will still come through. And obviously that's good news for emerging markets because it reduces funding costs, means less dollar pressure and allows ultimately many emerging market countries to cut rates, which help stimulate growth.

 But beyond that, we're clearly seeing the benefits of some of the big themes that we've highlighted from technology green transition, near shoring coming through and helping companies deliver better results. So we still think that has some way to go and certainly believes that that is one area that will continue to add value. And the third thing is that we do think that the China situation is stabilizing and again, just basic company results.

 I would say that the market is or the companies are significantly under priced and therefore great opportunity, but do recognize that there's a wall of concern that investors need to climb for them to perhaps return in great numbers into the Chinese market. So we need to be cognizant of that. But I do think that we're beginning to see that positive returns coming through.

Tom Harvey

Thanks for that Devan, pose a question to you. A bit of a broad one, perhaps, but it's about quality. Certainly. That's your investment style, looking at 2023, kind of in the rearview mirror, probably a tough year for quality in a lot of countries across emerging markets as we move and continue to move through 2024. What's your outlook for quality stocks to perform? To perform well, maybe to outperform?

Devan Kaloo

So I think just in context, when we talk about 2023, the key issue there really has been that in China, quality did not work and that was quite clear. So what we saw in China was that companies which we considered high quality companies which were actually delivered results. So on average earnings growth for our companies was circa 30% last year and got deviated.

 So the share prices fell quite sharply. Whereas in contrast, some of the poor quality state owned enterprises or value stocks did much better. And the key difference being this point about some of these quality companies being more generally held by private investors or domestic investors and foreign investors, whereas in contrast, many of these state owned companies being owned by the state and being supported by the state.

So we think that's an unusual situation. And then ultimately people will come back and focus on who's actually delivering the earnings for investors. More broadly, when I think about quality, I think what we're seeing today is increasing diverse performance across markets. So you've got some markets which are benefiting from very strong economic growth, which is allowing more companies to rise.

You've got some markets where growth is a bit slower and potentially interest rates remain so high where you're seeing difference performance. But what we do think is broadly speaking, when you think about the economic cycles, global economic cycle rolling over and slowing down, led by developed markets, and typically when that happens, that's associated with interest rate cuts and when that happens, things like US fact styles such as quality and growth do better than value.

So I think that a headwind of value doing better and quality and also is changing into a tailwind. 

Tom Harvey

Great, Devan, thank you very much. That feels like a good place to bring this podcast to a close. And Devan, I just want to thank you for joining us today. Thank you very much. It was a pleasure and thanks everyone who took the time today to listen in. If you enjoyed today, then please download our other podcasts from our website or wherever you normally get your podcasts. 

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