Dr. Carlos Asilis, Chief Investment Officer, Glovista Investments
Darshan Bhatt, CFA, Deputy Chief Investment Officer, Glovista Investments
July 6, 2023
EM equities underperformed the US and developed international equities in the first half of 2023, with the MSCI EM benchmark posting gains of 4.89% versus 11.67% and 16.84% for the MSCI EAFE and MSCI USA benchmarks, respectively. EM equities’ first-half of 2023 underperformance stemmed mainly from concerns surrounding China’s growth outlook and increased hawkish guidance from developed countries’ central banks.
Over the last few weeks, the global activity calendar has underwhelmed consensus estimates, as reflected in broad-based declines recorded by economic surprise activity readings for most of the world’s economic regions, except for the US. Similarly, long-term inflation expectations, as reflected via survey and market-based indicators, declined during the month resulting in a sizable fall in bond market volatility (e.g., MOVE Index).
On the policy front, developed country central bank actions and guidance proved more hawkish than expected, including larger than anticipated rate hikes out of the Bank of England, Bank of Canada and the Reserve Bank of Australia. Additionally, at the June meeting, the US Federal Reserve (Fed) upwardly revised its policy rate projections for the rest of 2023, while on June 28 Fed Chair Powell stated the 2% core PCE target is unlikely to be reached before 2025.
We expect a continued deceleration of economic activity, particularly in the developed world and the US. Several OECD (Organisation for Economic Co-operation and Development) economies have entered a recession (e.g., Germany, New Zealand and Sweden) while other large economies (e.g. China) are surprisingly negative, owing to the knock-on effects of the manufacturing sector activity resulting from a combination of the normalization of global supply chains and firms’ decreased need to hold high inventory levels, particularly as working capital funding costs have reset higher following last year’s succession of rate hikes across the developed world.
In the US economy’s case, we expect a continued deceleration of economic activity in the year’s second half. Recent economic releases point to a material softening of labor market conditions, as reflected in the latest US ISM non-manufacturing sector index’s employment readings and the US NFIB job openings indicator. In addition, the latest releases of private sector surveys evidence a marked decline in postings across most job categories outside healthcare, with most of the softness centered in the financial and information technology sectors. Looking ahead to the year’s second half, we sustain our baseline case of a modest US recession late in 2023/early 2024 as a result of several considerations, including:
- lower employment growth resulting from an ongoing decline in corporate profit margins
- decline in households’ disposable income growth, particularly for cohorts with a higher propensity to spend, as a result of the unwinding of several transitory phenomena that were highly supportive to aggregate demand during the year’s first half
From a market perspective, we believe that emerging market equities have the potential to post solid outperformance versus developed peers during the second half of the year, on the back of several considerations, including:
- our reaffirmation that the US dollar index’s cycle top was recorded in September 2022
- a sharp upturn in relative economic growth momentum between EM economies versus developed European economies and the US
- exceedingly cheap relative valuations between EM equities and developed peers, lending attractive entry points for global investors at a cyclical juncture in which the Fed is widely expected to bring its rate hike cycle to an end
- EM currencies’ compelling carry characteristics at a juncture in which bond and equity market volatility has been edging lower on a sustained basis for the past several months
- Global investors’ exceedingly underinvested status to the asset class
- Considerable potential for an impending start to policy rate cuts by many EM central banks as prevailing real interest rate levels are high by historical standards and running inflation momentum has been turning lower over the past several months
- China, the epicenter of investor growth concerns in the EM space, has witnessed a recent succession of policy stimulus measures announced by the government. Likewise, indicators of consumer mobility have remained resilient, boding well for a resumption of service expenditure growth despite the likely continued softness in the property market.
We look forward to seeing how the second half of the year plays out.
The views expressed are those of Glovista Investments, a boutique manager on the Spouting Rock Asset Management (“SRAM”) platform, as of July 1, 2023, and are not intended as investment advice or recommendation. For informational purposes only. Investments are subject to market risk, including the loss of principal. Past performance does not guarantee future results. There can be no assurance that any SRAM strategy or investment will achieve its objectives or avoid substantial losses. There can be no assurances that any of the trends described will continue or will not reverse. Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index.