Are we at the turning point for emerging market equities?

Hans Lee

Livewire Markets

"Don't Fight The Fed(eral Reserve)" is a time-tested adage in financial markets. 

The short explanation is that investors should make decisions in concert with the decisions of the world's largest central bank. That is, prepare for a more conservative portfolio when interest rates start to rise and vice versa. While this philosophy is generally geared towards investors who focus on developed market equities, the quandary is even more pronounced for those in emerging markets.

Emerging market assets traditionally have greater yields than those available in developed counterparts for two reasons. One is that their economies tend to grow faster. The other reason is that these assets tend to have higher risk premia.

Then, there is the third and less-talked about reason – which is directly relevant to the adage I mentioned earlier. Higher interest rates in the US and a stronger greenback make the debts of emerging market economies harder to service. Couple that with the ongoing effects of the COVID-19 pandemic and high inflation, and there's a fairly compelling case for why EM is still an avoid for many professional investors.

And the data reflects the caution - the iShares MSCI Emerging Markets ETF is down more than 17% this year alone, while the Vanguard Asia (Ex-Japan) Shares Index ETF is down nearly 14% year-to-date.

This has caused Dr Joseph Lai of Ox Capital Management to ask the inevitable question - are we near the bottom of this months-long underperformance in Asian equities?

In this edition of Expert Insights, Dr Lai explains to me why emerging market equities may finally be near a turning point despite all the macro headwinds still in play. We'll also discuss the biggest opportunities and risks that are tied to his core thesis.

For his complete view, watch the video or read our edited transcript below.


LW: Why are emerging markets due for a rebound?
If you look at emerging market equities in the indices from point to point from 10 years ago to now, it really has not moved, which is an amazing thing to think about. I mean, these economies are growing economies growing at 5%, 10% a year. Companies have been growing quickly as well, but yet the stock market has not moved. Now the take-home message here is that the valuation as a result has come down a lot in the last 10 years. 

And as an investor, it's a great place to start looking, given the scenario.

LW: How are Asian companies faring in this changing environment?
When we look bottom up, when we actually look at the companies which are operating in these countries, I mean, they're just travelling, just fine in most cases. And some countries are better than others. Some industries are better than others, but we can clearly identify certain sectors, certain countries which are still growing five to 10% a year with great companies, which are growing their earnings by 15 to 25 percent a year, and the valuation's very cheap. 

So some companies are doing really well and now it's just that, well, the valuations come off. So that's when we really get quite excited.

LW: Where are the biggest opportunities in Asian investing right now?
I'll start with the one that challenges most people, which is China. Our view is this, China is still going to grow. It's facing a few challenges. So in that area, we want to be selective in choosing the really great companies, which will continue to grow even in the face of more scrutiny from their own government and also external pressures. So that is that. And then we are being selective there and certainly not wholesale positive and get into it.

But we are finding interesting opportunities in other parts of Asia, for example, Indonesia, for example, Vietnam, and also India. 

The interesting thing about geopolitics, which is front of mind these days is that there's a bit of a fragmentation of the supply chain. People want to move some parts of the supply chain out of China. And you got to think -  "Well, the supply chain's going somewhere and some countries will benefit as a result of that." And so there are a lot of companies setting up shop, for example, in Vietnam, in Indonesia, and even in India.

For those who've been to India, it's actually something quite hard to believe, but India's doing well in these exports in the last 18 months. And that's the result of supply chains just ramping up. Going to these countries reminds me of China about 20 years ago. You see people migrating from the rural areas, settling in these cities, working in these factories that have just been put up, infrastructure ramping up, ports, electricity roads, and rail. And people's living standards are improving right in front of our eyes.

That was what China went through 20 years ago. Right now, we are seeing the same dynamic playing out in more than a billion people outside of China. The base is much lower. The income is much lower. And so, therefore, the up-charge in labour and the low-cost production is still very favourable for those countries. So it's very exciting to us to actually be able to basically reuse the same playbook in other countries, going through a very easy growth path.

LW: What is the biggest risk to your core thesis?
Lai: The risk would be in the new term in the volatilities in asset markets. If there are big concerns in, I guess, significant US monetary policy tightening, even from here, that can be an issue, but the reality is also that most people have been concerned about that for the last six to nine months. Interest rates have gone up. And so in the market, from a market perspective, I think there's a lot of expectation of interest rate going up and also globally economic slowdown to continue. At the same time, when we look at the stocks, they've gotten cheaper. So we think it's actually rather prospective [sic] from here.

Take advantage of the rapid growth in Asia and emerging markets

Ox Capital's investment approach is to identify the immense changes taking place in Asia and other key emerging markets to find investment opportunities. To learn more, visit our website, or see the Fund Profile below.

Managed Fund
Ox Capital Dynamic Emerging Markets Fund
Global Shares
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Hans Lee
Senior Editor
Livewire Markets

Hans leads the team's coverage of the global economy and fixed income. He is the creator and moderator of Signal or Noise, Livewire's multimedia series dedicated to top-down investing.

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