What Has Gone Wrong For Emerging Markets Equities in 2023?

It has been a disappointing year so far in 2023 for emerging market equities, according to market veteran Geoffrey Dennis.

MSCI EM is up 2.2% year to date as of May 16, in dollar terms, compared to a more bullish forecast. Dennis himself forecasts and maintains a 20% rise for 2023. In contrast, developed markets—MSCI World—are up 8.3% year to date.

This is an unusually poor EM performance in a rising equity market year, or up-year, for DM equities. DM markets have risen in 23 of the 33 years since 1990. During these DM up-years, MSCI EM has fallen seven times. The bulk of these—four of the seven years—were during the mid-to-late 1990s, when EM assets did very poorly as a whole after a set of EM fixed exchange rate systems collapsed around the world in a severe 'rolling' EM crisis.

Of the other 16 up-years for DM since 1990, EM has risen but lagged DM, as seen so far in 2023, in just two years—1996 and 2019. In the other 14 years when DM has risen, EM has outperformed.

This means that in 61% of the years when DM rose since 1990, EM equities have beaten DM, while in 87.5% of the years when both DM and EM equities have risen since 1990, EM has beaten DM.

I see EM tending to beat DM in rising equity market years due to the chase for risk and yield in bullish conditions; these years are usually associated with a falling U.S. dollar and rising commodity prices, which is good for EM; and EM equities are typically cheaper than DM, such that when conditions are right, EM outperforms.

So, why are EM equities lagging in 2023? The reasons are:

• By Numbers: Many big emerging markets have so far performed poorly in 2023. For example, China is down 0.4% year to date as of May 15, while India is down 0.9%, and South Africa is down 8.1%. However, despite Taiwan's 7.1% rise and Brazil's 3.3% increase so far in 2023, they trail the US growth rate of 7.8%. The GCC is down 0.6%, and the BRICs are down 0.2%. To underline, China (31.4% of EM at end-April) is down 0.4% year to date, while the U.S. (67.7% of DM) is up 7.8%.

• By Theme: The Chinese economic recovery in its post-Covid re-opening has disappointed.

• The US dollar has barely fallen, down 1.1%, in 2023 and has bounced since the late-January peak of MSCI EM.

• Ongoing U.S. recession fears even as the Fed keeps raising rates.

• The U.S. regional bank crisis since mid-March has net-net pulled money back towards safe-haven assets.

• The investment community began 2023 with long EM equities and short U.S. dollars, but neither has played out well.

So, why am I still bullish?

• As I have said many times before, I believe the Fed rate cycle is now over, or if not, almost over, which will tend to pull the U.S. dollar down and boost flows to EM.

• In the end, Chinese growth should be satisfactory in 2023—broadly in line with the government's forecast of 5.5%.

• EM equities have lagged DM for four of the past five years.

• EM equities are cheap—12.4 times trailing earnings at end-April compared to 19.4 times for DM.

• Several big EMs do look very attractive to me, notably China, India—where FII flows seem now to be picking up—Brazil, and Taiwan.

Currently, the biggest wild card risk is the debt ceiling process in the U.S.

Geoffrey Dennis is an independente emerging market analysts with over 35 years of experience as market startegist for various investment banks like UBS Investment Bank, Citi Group, Deutsche Bank and HSBC Securities

The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.