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Emerging Markets
Emerging markets: Positive signs even as China slows
F. Chapman Taylor
Portfolio Manager
Lisa Thompson
Equity Portfolio Manager
Brad Freer
Portfolio Manager
Kent Chan
Equity Investment Director

The post COVID-19 era has seen a reset in financial markets on many levels – interest rates, geopolitics and growth paradigms. It's also led to a redrawing of the landscape for emerging markets (EM). 


We believe the next phase of growth for EM will be different than the past 20 years. China's economy has matured and is going through a difficult patch of reforms. Geopolitical tensions and the world's energy transition are driving foreign investment into a broader mix of developing countries for manufacturing and natural resource needs. And government-led reforms are changing the trajectory of some developing countries, such as India and Indonesia. 


Many asset managers, including us, have increased their capital market assumptions for both EM equities and debt. We believe the outlook for EM is constructive over the medium-term and will expand to markets that have not been front-and-center for investors.


Here we discuss the macro variables as well as some of the trends and opportunities we are seeing across markets and industries.


Returns among large EMs have diverged post-COVID 

Chart shows cumulative returns from December 31, 2017 to September 30, 2023. The MSCI India Index returned 44.5%. The MSCI Mexico Index returned 31.7%. The MSCI China Index lost 26.5%. The indexes were fairly closely correlated until the COVID selloff in March 2020. Thereafter, the indexes diverged, with India and Mexico gaining the most and China dropping sharply. The steep selloff in Chinese equities began in early 2021.

Sources: MSCI, RIMES. Returns reflect MSCI India Index, MSCI Mexico Index, and MSCI China Index. Five-year time period shown to reflect returns pre and post-COVID. Data as of September 30, 2023.

Macro headwinds could become tailwinds


1. Inflation and interest rates are on a downward trend


Central banks in many developing countries, notably in Latin America, raised rates ahead of the U.S. Federal Reserve to blunt the impact of inflation. Most EMs lacked the ability to undertake quantitative easing over the last decade, which buffeted growth rates in developed markets. As inflation slows across some EMs, central banks in these markets are likely to pivot toward rate cuts in the coming months and quarters. Many have already started the process, including Brazil, Chile, Hungary and China. 


A decline in rates and inflationary pressures should provide a boost to economies and in turn to cyclical areas of the market. Monetary authorities will have to balance pressure on their currencies from declining interest rates against the boost to domestic economies. On balance, we believe lower inflationary pressures and declining rates should be positive for EM economies and stock markets.


Countries across Latin America have been more aggressive in tackling inflation

Chart shows core inflation and the central bank policy rate, respectively. For Latin America Brazil's core inflation was 6.14% and policy rate was 12.75%; Mexico's core inflation was 6.08% and policy rate was 11.25%; Chile's core inflation was 5.2% and inflation rate was 9.50%; Colombia's core inflation was 11.19% and policy rate was 13.25%; Peru's core inflation was 3.81% and policy rate was 7.75%. For Eastern Europe, Czech Republic's core inflation was 8.3% and policy rate was 7%; Hungary's core inflation was 15.2% and policy rate was 13%; Poland's core inflation was 10% and policy rate was 5.75%; Romania's core inflation was 11.4% and policy rate was 7%. For Asia, Indonesia's core inflation was 2.18% and policy rate was 5.75%; Malaysia's core inflation was 2.5% and policy rate was 3%; China's core inflation was 0.8% and policy rate was 3.45%; Thailand's core inflation was 0.79% and policy rate was 2.50%.

Sources: Capital Group, Bloomberg Index Services, Ltd. Core inflation is represented by the year-over-year change in consumer price index (CPI) excluding food and energy across countries. Inflation rate as of August 2023. Central bank policy rates as of October 5, 2023. Real interest rates reflect the true cost of funds to a borrower. Nominal interest rates equal the real interest rate plus the rate of inflation.

2Economies are fundamentally stronger 


The economic profile of many EM countries is much better than it was a decade ago. Government balance sheets are stronger. In 2021, the current account surpluses of developing economies totaled $480 billion, more than triple the amount recorded for 2019. And during COVID, unlike the case in many developed markets, policymakers in developing countries did not dole out large handouts to individuals, which helped their fiscal position.


Government reforms have improved the ease of doing business in countries like India. India's government has ushered in pro-business reforms and a digital identification system that have accelerated growth by facilitating the expansion of credit and bringing large swaths of the economy into the formal sector. Production-linked incentive programs designed to elevate India's domestic manufacturing base are also gaining traction. 


Indonesia has built more airports, roads and seaports, opened more industries to foreign investment and sought to cut red tape by making changes to labor and tax laws.  


EMs then vs. now  

Table shows statistics on emerging markets. China’s GDP per capita was 6,300 dollars in 2012 and 12,720 dollars in 2022. India’s GDP per capita was 1,434 dollars in 2012 and 2,388 dollars in 2022. Brazil’s GDP per capita was 12,327 dollars in 2012 and 8,917 dollars in 2022. Indonesia’s GDP per capita was 3,668 dollars in 2012 and 4,788 dollars in 2022. China's population was 1.3 billion in 2012 and 1.4 billion in 2022. India's population was 1.2 billion in 2012 and 1.4 billion in 2022. Brazil's population was 199 million in 2012 and 215 million in 2022. Indonesia's population was 250 million in 2012 and 275 million in 2022. Internet users in China were 42% of the population in 2012 and 75% in 2022. Internet users in India were 11% of the population in 2012 and 46% in 2022. Internet users in Brazil were 48% of the population in 2012 and 80% in 2022. Internet users in Indonesia were 14% of the population in 2012 and 66% in 2022. Equity market value of the MSCI China Index was 797 billion in 2012 and 2.1 trillion in 2022. Equity market value of MSCI India Index was 295 billion in 2012 and 1.1 trillion in 2022. Equity market value of MSCI Brazil Index was 522 billion in 2012 and 386 billion in 2022. Equity market value of MSCI Indonesia Index was 122 billion in 2012 and 145 billion in 2022.

Sources: MSCI, RIMES, World Bank, World Development Indicators. Internet users for India as of 2021. Equity market value represents the MSCI index for each country. 

3A weakening dollar should be supportive over the medium-term


The U.S. dollar is overvalued against most major and EM currencies on several metrics, according to our currency analyst. In the near-term, the dollar may maintain strength against several major currencies including the euro, the yen and the British pound, largely driven by interest rate differentials. In the medium-term, our analyst and global bond portfolio managers expect the dollar to weaken, or at a minimum, move within a range of current levels.


In the emerging markets, central bank policy rates are higher than the U.S. in many countries. Even as a few central banks have started to cut interest rates as inflation starts to move lower, nominal rates still remain higher. Many EM countries also have current account surpluses while the U.S. and other major developed economies are running deficits. This should bode well for EM currencies in the medium-term. We have started to see some EM currencies make advances against the dollar in the past 12 months, notably the Mexican peso and Brazilian real. This should be supportive of EM returns, purely from the currency translation effect in portfolios. But we do not expect it to be the major driver of our investment decisions.


Emerging markets have historically benefited from a weakening dollar  

Chart shows relative performance of MSCI Emerging Markets Index versus the MSCI World Index from January 31, 1991 to August 31, 2023. Emerging markets outperformed developed markets from 1991 to June 1996. Developed markets outperformed emerging markets from July 1996 to May 2001, a period when the dollar generally strengthened. Emerging markets then outperformed developed markets until April 2012, a period when the dollar generally weakened. Developed markets have outperformed emerging markets since, a period when the dollar generally strengthened.

Sources: Capital Group, J.P. Morgan, MSCI, Refinitiv Datastream, RIMES. Relative returns data represent cumulative rolling monthly three-year total returns of the MSCI Emerging Markets Index vs. the MSCI World Index in U.S. dollars, with positive values reflecting periods of outperformance by the MSCI Emerging Markets Index relative to the MSCI World Index, and negative values reflecting periods of outperformance by the MSCI World Index relative to the MSCI Emerging Markets index. U.S. dollar is represented by the J.P. Morgan Real Broad Effective Exchange Rate Index. As of August 31, 2023.

China is the elephant in the room


China's rise as a major manufacturing powerhouse and its property boom drove global commodities demand and powered EM from 2000 to 2010. China became the dominant constituent in the MSCI Emerging Markets (EM) Index, making up 43% of the index's weight at its peak. That figure has declined to 29% as an economic slowdown and government regulation of several areas of the economy took its toll on the stock market.  


Going forward, China has matured and its $18 trillion economy is likely to grow at a slower rate. The government has taken a piecemeal approach to fiscal stimulus and will have to address how to reform and resurrect a highly indebted property sector. More importantly, having built out world-class infrastructure that has set up the economy for the modern age, the next phase of China’s economy will have to be powered both by the consumer and by moving further up the value chain in manufacturing and technology. In areas such as robotics and electric vehicle battery technology, China is already showing its prowess as a high-end manufacturer.


However, consumer confidence has been battered by strict COVID lockdowns and the woes of the property sector and will need both time and government efforts to be restored.  Nevertheless, we remain optimistic that this will happen over time. There are many areas of China’s economy where domestic consumption will be the key driver of growth. These include pharmaceutical treatments, autos, video gaming, e-commerce, and financial products. Companies in these areas range from small to large and a few have emerged as multi-nationals. 


Auto and battery manufacturer BYD and carmaker Geely are good examples. Both began as domestic manufacturers. By focusing on newer technologies of battery development and efficient manufacturing of electric vehicles, they have joined the ranks of the largest auto manufacturers worldwide. China is on course to surpass Japan to become the world’s largest exporter of automobiles, a feat that was unimaginable a decade ago and a reminder of how quickly the country can gain market share in an industry.


China’s emergence as a leader in electric vehicles challenges the dominance of German carmakers that have enjoyed a large market share in China and other EMs. This might contribute to ongoing geopolitical tensions and could result in tariffs and other restrictive measures. 


Greater competition, at times marked by geopolitical tension and negotiation, is expected to characterize many industries over the next decade, be it electric vehicles (EVs), industrial automation tools or semiconductors. But with talented entrepreneurs, China and its companies are likely to be in the mix by either emerging as global leaders or dominating their own domestic market or as providers of components along the supply chain.


China's weight in the EM benchmark peaked in late 2020

Chart shows percentage weight of MSCI China Index in the MSCI Emerging Markets Index from January 31, 2002 to September 30, 2023. The MSCI China Index began at 5.4%. It steadily rose to eventually peak at 43% in October 2020. The index then declined to 30%. Labels on the chart indicate: From 2002 to 2007: China commodities boom. November 2008: China unleashes $586B stimulus to support global economy. November 2012: Xi Jinping named general secretary of CCP. July 2018: U.S.-China trade war begins. November 2020: Ant IPO postponed. First half of 2021: Regulatory crackdown on private sector. Second half of 2021: Property developers face liquidity crunch. December 2022: China ditches zero-COVID policy.

Sources: MSCI, RIMES. Postponement of Ant IPO contributed to selloff in Chinese equities. Data reflects January 31, 2002 to September 30, 2023.

Is China investable? 


Often, we get the question: Is China investable?  Our answer is not a binary yes or no. The reality is that China is an integral part of the global economy, especially given the large volume of trade and cross-border investment between Europe, Asia and the emerging markets. Do these regions want to reduce dependence on China as the growth engine of many industries? Yes. Can Europe, the U.S., Japan, India or other emerging markets completely disentangle from China’s economy? No.


Over the last few years, investors have swung from wanting to maximize their China exposure to having very few investments. The sharp selloff in Chinese equities since 2021 has weighed on the EM benchmark, leaving investors vulnerable to volatility, especially those who had exposure to China through a passive index vehicle, which typically seeks to track the weight of a particular benchmark. 


As such, it is incumbent for asset managers and other investors to investigate firsthand and calibrate which areas, industries and companies are best positioned to benefit from these secular shifts and trends. We think this represents a good opportunity for active managers.


Geopolitical tensions can benefit emerging markets


The reconstruction of supply chains in many industries may benefit the developing world and help drive new sources of growth for a broader set of countries.


For instance, rather than aligning with one economic superpower, countries like Indonesia, India, and Mexico are tapping into funding and investment from both leading Western countries and China. Furthermore, in seeking to diversify their supply chains, multinationals are also setting up manufacturing facilities across different geographies. Chinese companies are also diversifying abroad, some of them setting up final assembly for export to the U.S. in countries like Mexico.  


A rise in foreign direct investments (FDI) can have positive effects on local economies. When a multinational builds a manufacturing plant, it often draws in investment from other companies in the supplier ecosystem who also establish a physical presence in that particular region of the world. And FDI investments have tended to be sticky compared to portfolio flows. In addition to being a longer term capital investment, FDI flows typically have a multiplier effect on economies, generating employment which in turn stimulates consumption.


Supply chain shifts broaden the investment landscape  


The diversification of global supply chains should benefit several different markets. 


Indonesia is making a concerted push to be a major nickel processor and an integral part of the supply chain for electric vehicle batteries, leveraging its position as the world's leading supplier of nickel, an essential mineral for EV batteries. In 2020, the country's president banned exports of unprocessed nickel ore as part of a broader plan for the country to transition from being an exporter of raw materials to a value-added metals processor.


Relative to its boom-bust history driven by commodity cycles, success here could be transformational for the economy. Capturing a greater share of the entire supply chain, from smelting nickel to battery and car production, could change the country's economic profile.  


Indonesia has lured foreign companies to invest. China's state-owned enterprises have spent billions of dollars to help finance and build nickel refinery plants in the country. Meanwhile, multinationals from South Korean auto company Hyundai, German chemical maker BASF and U.S. automaker Ford have all inked agreements to be involved in nickel processing.


Mexico recently replaced China as the largest trading partner of the U.S. With a strong foundation in automobile and small-electronics manufacturing, investment today is broadening to medical devices, more complex electronics, furniture and general industrial goods.


Foreign direct investment has been rising. Some of the largest investments have come from automakers Tesla and BMW and electronic component makers Bosch and Continental. Another large investor is Japan-based Daikin, which is expanding its manufacturing footprint for energy-efficient air conditioners.


On our recent trips to Mexico, the scale of new manufacturing and distribution facilities under construction reminded us of China in the early 2000s. There's also been an influx of Chinese manufacturers into the northern Mexico states, which are being used for final assembly for electronics products shipped into the U.S. Chinese companies have accounted for roughly 40% of leasing activity for manufacturing facilities in the past two years, local real estate sources have told us. Altogether, China's direct investment in Mexico for computer equipment manufacturing totaled $282 million in 2021-2022.   


Asia is well positioned for the rewiring of global supply chains

The image shows the top destinations companies are choosing when redirecting investments from China. According to a survey by AmCham Shanghai, 57% of redirected investments from China are going to Southeast Asia, 30% are going to the United States, 29% are going to Mexico, 23% are going to Europe and 22% are going to India.

Source: AmCham Shanghai 2023 China Business Report, published 9/19/23. Based on a survey of 325 foreign companies doing business in China. Of those companies, 40% said they were redirecting investments from China to other locations, including Southeast Asia, Mexico, India and the United States, among others. Survey respondents could provide multiple responses, so total does not add up to 100%.

India has been expanding its manufacturing capacity for mobile phones, home appliances, computers and telecommunications equipment. The government has been aggressive in courting Japanese, Taiwanese and U.S. companies to invest in new capacity, including Apple, Foxconn, Daikin and Mitsubishi Electric. 


The playbook for the Indian government is twofold: ramp up capacity to serve the domestic population and over time become a larger player in export markets. It also wants to develop a supply chain ecosystem, as a wide array of product components are imported. 


India, like China early in its development, has been investing in the building of ports, roads, housing, and industrial warehouses. This is preceding the manufacturing transition and could be additive to the economy and help sustain economic growth.


The energy transition could be another growth tailwind. Since the last mining super cycle ended in 2011 with overleveraged balance sheets and excess capacity, mining companies have become more financially disciplined, focusing on value over volume. They also spent more cash flow on distributions to shareholders over increasing capacity. Now, with the global push to build energy-efficient vehicles, power grids and buildings, there is growing demand to secure supplies of copper, nickel, iron ore and lithium. We anticipate this will drive major investments into new mining projects in parts of Africa, South America and Asia.


A dividend culture prevails in many markets


A culture of dividends has prevailed in many emerging markets, as historically many companies were part family-owned, and depended on the payouts. And while capital markets have expanded and family ownership has declined, the culture of dividends has persisted. Corporate managements have shown an inclination to support dividend payments through different economic and market cycles and worked it into their capital allocation and planning. 


The number of companies in the MSCI EM Index that offered a dividend yield higher than 3% totaled 468 as of September 30, compared to 349 for international markets (MSCI EAFE) and 147 in the U.S. (S&P 500).  


As would be expected, dividend payouts tend to be higher in traditional industries such as telecoms, banks and industrials and less so in the newer technology companies. This allows us to build rounded portfolios of pro-growth cyclical companies and dividend-oriented corporations.


EM has evolved and so have the opportunities  


We've also been digging deeper into developing countries that are not the traditional index heavyweights of China, India and Brazil. Our EM-related funds have made incremental investments in Mexico, Indonesia, South Africa and Saudi Arabia over the past year. And perhaps over time, these countries may be larger in our funds than they have been historically. 


22 years ago, the phrase "BRICs" was coined to describe the potential for the emerging markets of Brazil, Russia, India and China. Not all have lived up to those heady expectations, and EM equities have lagged developed markets for the past decade.


We do think durable trends — reshoring of supply chains, powerful shifts in demographics, infrastructure growth, the energy transition, the emergence of sticky and large domestic brands – could add more depth to EM equity markets. 


Furthermore, government balance sheets are stronger, inflation is coming under control and a decade-long bull market for the U.S. dollar may be abating. On top of that, valuations for nearly all sectors in the MSCI EM Index are near 10-year lows, making for an attractive asset class over the medium- to long-term. 



F. Chapman Taylor is an equity portfolio manager with 33 years of investment industry experience (as of 12/31/2023). He holds an MBA in finance and strategic planning from the University of Pennsylvania, and a bachelor’s degree in physics and theology from Tulane University.

Lisa Thompson is an equity portfolio manager with 35 years of investment industry experience (as of 12/31/2023). She holds a bachelor’s degree in mathematics from the University of Pennsylvania and is a CFA® charterholder.

Brad Freer is an equity portfolio manager with 31 years of investment industry experience (as of 12/31/2023). He holds a bachelor’s degree in international relations from Connecticut College and is a CFA® charterholder.

Kent Chan is an equity investment director with 32 years of investment industry experience (as of 12/31/2023). He holds a bachelor’s degree in political economics from the University of California, Berkeley.


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