Emerging market equities: CapEx, chips, and a charging China

From capital expenditure catalysts to geopolitical crosswinds, tune in to hear why Global Head of Equities Devan Kaloo remains bullish – and what risks he’s watching.

Transcript

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

Devan Kaloo: Thank you very much. It's great to be here again. 

Tom: Certainly, interesting times. In many equity markets, emerging markets, you know, pleasingly performing quite well year to date. We'd love to hear your thoughts about, perhaps what's been driving things, what you guys are focusing on today. 

Devan: Yeah, absolutely. And I think, that point about the strong performance at emerging markets is probably the one I'm going to major on, and then maybe talk a little bit about that, because I think if you had asked me at the beginning of this year whether or not we would see emerging markets, being almost 13% ahead of the S&P 500 year to date, I would say that's probably very unlikely. So, there's been a lot going on in emerging markets. And when you see, in Q3, when the markets were up 11%, that was again beating developed markets up around seven and the S&P 500 up about 8% of that same period in dollar terms. And the standout year in terms of performance has really been China, which is up 21% over the three months and almost 42% year to date. So, there's been some really big moves and that's been great for the asset class. And the interesting thing for this quarter or the quarter just past, has been that this has been done against the backdrop of where the dollar's been flat. So in the first two quarters we've seen the dollar weakness. And that's helped certainly in terms of the asset class. So, in terms of the drivers that we've seen leading markets higher, I think I would probably highlight a few things. The first is that rather like the US, you seeing AI mania. So, the focus on the increased AI CapEx spend and beneficiaries of that, which is certainly gripped the US market, has broadened out very clearly to the rest of the world. And indeed, emerging markets are very much in the forefront of that, led by, China. And one of the interesting features, you know, of course, is that, you know, in 2024, people were concerned about the increasing concentration of the S&P 500 in terms of the mix sevens dominance. That dominance has continued. And I suppose the good news in terms of things that we are seeing, though, is that we are seeing a broadening out of that, move in various AI related names. And that's very much the case in emerging markets as well. The second big theme that we've seen dominates headlines is really beaten around the rate cuts or the easing cycle. So, we saw the fed, announced their first rate cut to 25 basis points in September and signaling, some easing to come. And that of course is very positive for emerging markets. More generally because certainly allows emerging markets, central banks to potentially cut their rates, but also puts pressure or reduces pressure, I should say, on currencies as well. And as a result of that, you certainly seen some of these markets doing a lot better as a result. But I think the third feature, which we probably have to acknowledge, is that the market seems to be looking for pretty much any risk, which currently is being highlighted. So, buoyed by this tech enthusiasm. But the rate cuts by the somewhat better than expected economic data coming out to the US investors is largely ignored. Or the other stuff that's gone on. And there have been a few things of some concern. So, certainly out of the US, we've seen the move to more politically motivated tariffs. So, India, for instance, as well as Brazil, have been on the receiving end of that. But we've also seen an increasing rise of tensions between Europe and Russia. And potentially, you know, that has longer term implications for markets and indeed economies. Plus, we've completely moved through and beyond, the Israeli bombing of, US ally Qatar. So, there's a lot of risks that have been arising over this period, which the markets have looked through. And, potentially, we it's worthwhile just remembering that because, not, not, it's not always the case that good times continue. 

Tom: Great. Thanks, Devan. And so, with that as a backdrop, what has that meant for our strategies? 

Devan: Well, I suppose the good news for us is that our funds, generally, circa 400 basis points ahead in Q3 and that means it's a year to date, about 100 basis points ahead. So that's good. Certainly, stock selection has been the key driver within that. But if I broke it down into some of the big themes that have been driving, that relative performance, I suppose is a few things that highlights. Certainly, China's been, standout for us. And Q3 and that's really good to see because, you know, we've taken some pain in China over the last few years by refusing to get involved in some of the state-owned enterprise value stocks and instead focusing on the private enterprise or growth orientated stocks. Those stocks, in particular, around the tech- and AI-related space have done very, very well over this period for us. And that's great to see. And that's reflects a few themes coming to you. One, obviously, China Tech has shown that they can compete with US tech to do is an increasing localization theme where more and more Chinese tech companies are being, looking to move, supply, domestically to limit the impact of the US tech restrictions. And three, actually, many of these companies are better utilizing some of the new tech coming to you from AI in terms of their business models. And actually, that's at improving in some cases, margins and the like. So, you’ve seen some really interesting things happening in China. And as I said, the key in terms of the market has been this AI tech. If you look more broadly than that, actually the Chinese economy is a bit still. Ho hum. Consumers remain still relatively weak, and you've not seen a major recovery in the property market. So a lot of the action – as I mentioned – has really been on the tech side of things. The second big theme, which I think is worth flagging has been CapEx. So, I mentioned at the beginning about the AI mania and the increasing CapEx that we're seeing out to the hyperscalers and the US tech companies more generally. But one of the things that has fallen out from that has also been the acceleration of the electrification theme, which is a theme that we've been particularly keen on for some time now. And we've seen, plays on that, both direct and indirect are doing very well. So you've had commodity companies offering copper, doing well. You've had industrial companies, making parts for the electricity grid system or power stations doing very well. And of course, you've had many more tech companies which are the beneficiaries of the CapEx spend or the direct beneficiaries of CapEx spend also doing well over this period. And they've been in places from Taiwan to Korea to Mexico. So, it's been a broad, broad geographic beneficiaries. From what has been quite a strong theme of increasing CapEx spend. And, certainly, that is something that we've been very encouraged by. But the other thing I'd probably note here is that, you know, the last few years we've seen value doing very well in emerging markets. And I think probably from the end of Q2, going into Q3, we started to see a rotation. So, growth as a style has started to come back. And certainly, that's been led by some of the tech, names and stories, but also broadening them more widely. And of course, a decline in interest rates is also supporting some of the multiples and multiple expansion for some of these growth companies.

So, we think we are in the beginnings of growth. Well, a value to growth, rotation. And that certainly is beneficial for us. The one point of note, I would just add here, though, is that going back to my point about investors, not really focus too much on risk at the moment is still really isn't a premium being placed on companies with strong balance sheets, great cash flow, good management teams or historically good management teams. And that is something which I do think we need to pay attention to because, you know, it is a still a world which is uncertain. And as a result, I do think quality will come back, in terms of being an important driver performance, but just to balance out some of the what appear unremittingly. Good news I've just talked to. It is worthwhile highlighting that India has been a real poor performer in Q3. Now there are several things to that, but as I mentioned earlier on, India has been, smacked by US tariffs as, the US has tried to get India to reduce its reliance on use of Russian oil as part of its wider Ukraine, war negotiations. The Indians have refused and as a consequence, the tariffs have remained in place. And that certainly has been pretty negative for sentiment on India, particularly from foreign investors. Now, I say on sentiment because in terms of an economic consequences, the tariffs are less relevant. India being a largely domestic orientated story, but even on the domestic side of things, things have not been great either. So, the Indian economy has now been slowing for about a year. And would that earnings have been coming down. So put that together and you have a market which has been a major underperformer in Q3, but also year to date. That said, we are still positive on the outlook for the Indian market, and there's a few things for that one. We do see the Indian government responding to some of these difficulties by enacting some reform. So they've announced the simplification and the reduction of taxes in India. And in addition to that, the reserve Bank of India or the central Bank of India has moved to try and support and helps, stimulate the economy, which is all good for the longer term. It is also worth while bearing in mind that India at the moment doesn't really have much by the way of AI themes. And as a result, perhaps is being forgotten in this AI mania which has. And when, perhaps some of that mania reduces, you could see India do better as well. So certainly, we maintain US position in India and still positive about what's happening on the ground. And as a result, then constructive if I try to bring that all to some sort of conclusion. I think the key thing I would say in terms of the outlook is that were pretty constructive. I think that, there's three elements here, which I would highlight. The first is that we do believe that the dollar will continue to remain weak. Whether it's about peak, U.S exceptionalism or whether it's the changing rate cycle. We don't see huge support for the dollar here. And that, as I mentioned, the very beginning is good for emerging markets. The second is that we do believe strongly in this CapEx feed. So, I talked about AI and electrification. But similarly, the supply chain changes that we're seeing is also pretty good for many emerging market countries. And they're benefiting from that. And we see that across the board and lots of opportunities. And the third thing is valuations. So, despite emerging markets having done very well this year, they still trade at relatively cheap valuation versus the peer group. So, say the US markets or European markets. But similarly cheap relative to its history. So, on that basis, you know, we still think that there's scope for emerging markets to do better from here. But I would be remiss if I wasn't, pointing out as well that we've seen a very strong rally in markets globally. It has been fairly narrow in terms of that AI story. And while we are constructive an AI for the moment, we are very conscious that there is some risks emerging here. But for the moment, we still remain very bullish about emerging market equities. 

Tom: And that feels like a good place to bring this podcast to a close. Devan, thank you for joining us today. 

Devan: Thank you. 

Tom: And thank you to 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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