Sharing his latest outlook and analysis with us, Charles Walsh, manager of Mirabaud – Equities Global Emerging Markets, explains why he’s in a positive frame of mind and sees the recent Fed cut as the start of a new rate-cutting cycle which should support EM equities going forwards.
After several years of price decline, we see emerging market (EM) equities as poised for a resurgence. Already one of the best-performing asset classes of 2024, we see further upside from here. This is based on a clear reversal of recent headwinds, notably higher US interest rates and a strong dollar.
Perhaps the greatest of pressures on EM equities over the past few years has come from within, in the form of declining corporate earnings. This came at a time of accelerating earnings from US corporates, which are now poised to slow.
Corporate earnings in some EM sectors, most notably technology, troughed some quarters ago, but this recovery is broadening out and can now be seen rebounding at an index level. We are also seeing the beginnings of an improving demand environment, meaning revenue growth is also supporting earnings so we’re no longer reliant on cost-cutting to drive earnings growth.
But the key tailwind that we believe should now support EM equities, is the fact that the US Federal Reserve (Fed) has begun its rate-cutting cycle. Higher US interest rates over the past few years translated into a stronger US dollar, which in many cases led to EM countries hiking domestic rates to protect their currencies. Absent a meaningful inflation problem in EM, this simply led to slower growth.
With the Fed now embarking on a new rate-cutting cycle, we expect this to herald the beginning of a growth-boosting rate reduction cycle across much of EM, reducing the debt burden on businesses and consumers alike, and removing the cork in the bottle that had artificially constrained growth.
Another tailwind during this Fed cutting cycle that is not normally present, is a healthy US consumer. Interest rate cuts usually begin during a weak growth environment and the retrenchment of a cautious consumer. This time, however, healthy US employment and a global business cycle that’s still in relatively early stages are supportive of overall demand, global growth and EM’s export-reliant economies.
Additionally, we must consider the drag on EM equities that came from decelerating growth in China, in large part due to the issues with its property sector. Whilst it’s too early to convincingly call the bottom for China property, high-frequency data points to secondary house prices having troughed in some cities.
Recent moves by the Chinese government to support property and stimulate the economy via monetary, fiscal and regulatory measures have very real chances of providing a floor to the property sector and boosting both sentiment and activity. Moreover, they signal a clear intent from the government that it recognises the scale of the challenges facing the economy and is prepared to take bold steps to address them.
Given the pressure exerted on EM equities and the wider demand environment by the weakness in China and its property sector in particular, a stabilisation of housing prices and a more accommodative financial environment should provide meaningful support for both EM activity and broader sentiment.
Besides the larger and more obvious countries within EM, we are minded of the diverse and heterogeneous nature of the asset class. South Africa, long ignored due to structural and political issues, is enjoying a well-deserved resurgence in investor interest following the newly formed “national unity” government.
Elsewhere, Mexico has slipped down the ranks of attractiveness due to judicial reforms that are hurting business sentiment and weakening the currency. However, the re-shoring theme in which Mexico has played such a key role can also be accessed in other countries across ASEAN.
These shifting tides within the asset class present interesting potential opportunities for the active EM investor to extract value and manage risk.
Finally, and perhaps most significantly, EM equities remain a growth asset class even whilst growth slows across the rest of the globe. Home to roughly 85% of the world’s population, the asset class sits at the heart of some of the most promising structural themes globally. With the addition of cyclical tailwinds from global macro and domestic factors, we believe the outlook for EM equities is the strongest it’s been for many years.
