Emerging market stocks are off to a strong start in 2023
Emerging market stocks are off to a strong start in 2023, even as investor concerns remain. Emerging markets have underperformed in the past two years as a stronger dollar, higher interest rates from central banks around the world, and the continuing impact of the pandemic have stunted growth. The iShares MSCI Emerging Markets ETF (EEM) fell more than 22% in 2022, and more than 5% in the previous year. But that picture appears to have changed this year. EEM has advanced more than 8% this year, compared to the S&P 500’s rise of 1.5%. Cheaper valuations have made emerging market stocks attractive to investors, with a weaker dollar, easing inflation and China’s reopening expected to be a boon for these assets. “One of the main attractions of emerging markets is compelling valuations,” said Quincy Crosby of LBL Financial. “Again, they’ve been neglected. Brazil has done well, except again, India has done very well, and they’ve been neglected mainly by portfolio managers.” However, investors differ on the outlook for emerging markets from here. Outlook Carlos Aciles, co-founder and chief investment officer of Glovista Investments, has an optimistic view of emerging market stocks, recommending that investors take a hyperbolic stance. If emerging market stocks represent a 10% benchmark allocation in a global equity index, Asilis said investors should take a 12% weighting. For higher-risk investors, he said, this allocation can be as high as 20%. “I would say 12%, 11% is almost neutral, right? It makes sense if it’s at least 12%. And then maybe between 12% and I say 16% makes sense,” Asselis said. He added that most investors would find this a reasonable level of exposure. Others have taken a more measured stance. BCA Research’s Arthur Bodagian said he did not expect the current rally in emerging markets to be sustainable, urging investors to wait on the sidelines for a better opportunity later this year. He predicts that the outperformance of emerging markets may stall or partially reverse in the next two months. But that could be a boon for investors looking to get in later this year. “I think we’ll get a larger buying opportunity or increase in importance sometime in the middle of this year in the second half,” Bodajian said. He predicts that the reopening of the Chinese economy will rebound more meaningfully in the second half, boosting economies in emerging markets. Moreover, the slowdown in growth in those economies, caused by monetary policy tightening, may reverse later this year as well. Budaghyan recently opened an emerging markets upgrade watch, but remains less heavy on it in its global equity portfolio. It is expected that it would be better for investors to keep their money in the international money or bond markets during the next several months. Meanwhile, LBL Financial’s Crosby said the rebound in emerging markets may be short-lived, saying that any increased level of liquidity could lift valuations to a less compelling level. “Any indication that the market has the Fed is wrong, and any indication that the Fed might actually move to 50bp against a potential 25bp… would put a bid on the US dollar,” Crosby said. Not All Emerging Markets Are Equal Even as emerging markets outperform broadly, some countries are expected to perform better than others. Many market participants expect Chinese stocks to outperform their peers this year – despite some lingering concerns about travel. “A lot of our peers were underweight China, and they underperformed significantly last year and the beginning of this month, so I think there’s a lot of Chinese stock buying on the horizon,” Glovista’s Asilis said. The iShares MSCI China ETF (MCHI) is up more than 12% this year, after falling 24% in 2022, and 22% in 2021. Other markets Asilis finds attractive are Southeast Asia, Taiwan, South Africa and Brazil. Meanwhile, BCA’s Boudajian said he would be overweight in Mexico. While the country has exposure to the United States, which Budaghyan has a negative view of, it has exposure to the auto sector. The iShares MSCI Mexico ETF (EWW) is up more than 13% in 2023. Budaghyan added that Mexico is benefiting from a region of the US that continues to see strong demand — and that’s because supply shortages previously made it difficult for people to buy cars. The strategist also prefers exposure to South Korea and Chile. iShares MSCI South Korea ETF (EWY) and iShares MSCI Chile ETF (ECH) are up more than 10% and nearly 1%, respectively. One sector Budaghyan will avoid is Chinese tech companies such as Alibaba, Baidu and Tencent. The strategist has concerns about the long-term prospects of these companies, given the increasing government involvement in the business.