Slowing economic growth in developed markets against rising growth in many emerging markets (EMs), along with increasing capital investment, is likely to be a key theme in coming years, with the potential for strong outperformance by EM share markets, according to Steven Gray, the head of global emerging markets (GEM) at Eastspring Investments.

“Emerging markets are very unloved at the moment, and have de-rated considerably since 2010 - from trading at a premium relative to developed markets, to trading at a huge discount relative to developed markets,” said Mr Gray, as the charts below show.

“While EMs have disappointed, that is priced into markets. So relative valuations are now very attractive to investors and expectations are low.

“EMs now represent an exciting value and diversification opportunity for investors as EMs often behave differently to developed markets,” he said.

According to Mr Gray, EM equities have both a strong valuation and structural tailwind relative to developed market equities, which may lead to superior performance across EMs from here. Increased capital expenditure (capex) will help drive some of this outperformance.

“Emerging markets typically outperform as capex increases. Capex had been decreasing between 2010 and 2020, but since then, we have started to see an increase in capex across both developed markets and EMs.  Capex continues to be on the rise.

“Historically there is a strong positive relationship between increasing capex and the performance of EMs, with markets outside China benefitting from increased exposure to materials, industrials, and financials.”

In terms of particular EMs, he said: “We think China is very unloved at this stage, though it has a more managed economy, which has its upside and downsides. But it is very cheap and therefore an interesting investment proposition.

“China is now stabilising and recent data points to improving economic conditions. Today, China is a leader in the electric vehicle (EV) manufacturing space and renewable energy supply chains which is likely to be a longer-term structural support for the economy.  At current valuations, China offers some compelling investment opportunities.”

Outside of China in other EMs, structural factors such as geopolitics and shifting economics are raising capex and spurring economic growth, according to Mr Gray.

“Capex cycles are supportive for EMs as a whole and we see several drivers such as the ‘great transition’ of supply chains away from China to other emerging markets, a greater focus on investing in decarbonisation and broad based investment in infrastructure supporting stocks in real economy sectors across EMs.”

Eastspring believe the great transition is a long-term theme, which can yield opportunities for many economies and companies across EMs. The largest beneficiaries of this transition are likely to be in ASEAN, Latin America, India, the Middle East and Africa – all markets with cheap labour and decent manufacturing bases that are major producers of key commodities. Most have a large and young population base, and a high economic growth potential which can be exploited by this great transition.

The combined manufacturing value add of these countries is less than half that of China. As such, a small shift of supply chains away from China adds a significant amount of manufacturing value add to these countries and create interesting investment opportunities.

‍

‍