Is it time to invest in emerging markets?

Episode Summary

Executive Summary: The discussion argues that emerging markets are improving after a difficult 2022, driven by China’s reopening, a stabilizing semiconductor cycle, resilient EM balance sheets, and better earnings quality in 2023. While headline EM earnings may be flat to slightly down, select countries and sectors—especially India, higher-quality sovereigns, and EM corporates—look more attractive amid fair valuations and improving liquidity.

Main Topics: Why EM is outperforming after a weak 2022 (Priority: 5/5): Speakers attribute the rebound to easing macro headwinds, China’s reopening, and a likely bottoming in the semiconductor cycle, which together improve the growth backdrop for EM equities. U.S. rates, dollar strength, and EM debt (Priority: 5/5): Higher U.S. rates and a stronger dollar still pressure EM, but the impact is more muted than in past cycles because many EM borrowers have improved funding structures and rely more on local currency debt. China reopening and spillover effects (Priority: 4/5): China’s shift away from zero-COVID and pro-growth policy changes support EM via trade, tourism, and commodities, though the boost is described as marginal rather than transformative. India as a structural winner (Priority: 5/5): India is highlighted as a long-term growth story supported by reforms, domestic demand, infrastructure investment, and sustained earnings growth, even after strong relative performance. Earnings quality across EM in 2023 (Priority: 5/5): Overall EM earnings may be weak, but the composition is improving: commodity-driven sectors face tough comps while consumer, financial, healthcare, and other structural growth sectors are expected to post stronger growth. Liquidity and financing conditions (Priority: 4/5): EM financing conditions have improved in early 2023, with strong issuance and better market access, though weaker credits remain shut out and differentiation is increasing. Debt restructurings and country selection (Priority: 4/5): Ongoing restructurings in distressed sovereigns are lengthening due to more complex creditor groups, including China, making recovery outcomes worse for bondholders and borrowers.

Key Arguments: EM underperformed in 2022 due to U.S. rate hikes, dollar strength, China’s zero-COVID slowdown, and a semiconductor inventory correction. China’s reopening and policy pivot toward private enterprise and real estate support EM growth and sentiment. The semiconductor cycle is nearing a bottom, reducing one major drag on EM equities. Higher U.S. rates matter less when they reflect stronger U.S. growth rather than inflation panic, and EM fundamentals are better than last year. EM sovereign and corporate balance sheets are generally more resilient because many issuers fund in local currency and have reduced dollar-peg/dollar-debt exposure since 2008. EM central banks hiked early and many have already peaked, while fiscal tightening since COVID has improved resilience. India benefited from post-COVID recovery, structural reforms, and strong earnings growth; its growth outlook remains more domestic-demand driven and less tied to global cycles. Headline EM earnings may decline modestly in 2023, but the underlying quality is improving because weaker commodity comps are offset by stronger structural sectors. EM valuations are fair versus history, but still at a discount to U.S. markets, leaving room for multiple expansion. EM liquidity conditions have improved markedly in 2023, but access remains selective and favors stronger credits and sovereigns. Long-running sovereign restructurings are more complicated because China is now a major bilateral lender, slowing negotiations and harming recovery values.

Data Points: EM equities valuation (forward P/E): 11.5x - Current one-year forward P/E for EM equities, roughly in line with the long-term average. EM equities valuation (forward P/E long-term average): 11.4x - Historical average cited for comparison with current EM P/E. EM equities valuation (forward price-to-book): 1.6x - Current one-year forward P/B for EM equities, below the long-term average. EM equities valuation (forward price-to-book long-term average): 1.8x - Historical average cited for EM P/B comparison. EM discount to U.S. equities: 35% - Current EM valuation discount versus U.S. markets. EM discount to U.S. equities long-term average: 25%-30% - Historical average discount range referenced by the speakers. EM interest payments as % of GDP increase since 2019: 0.3% - Used to show that higher rates have not yet caused dramatic sovereign debt deterioration. India real GDP growth in 2022: More than 7% - Supports the case for India’s strong cyclical recovery. India cumulative equity outperformance: More than 50% over two years - India outperformed MSCI EM / MSCI China in 2021-2022. India earnings growth outlook for 2023: 16%-18% - Projected corporate earnings growth for India. China earnings growth outlook for 2023: About 14% - Projected corporate earnings growth for China. EM earnings outlook for 2023: Low- to mid-single-digit decline - Headline EM earnings may be weak overall despite stronger underlying quality. Structural sectors earnings growth: Double-digit - Consumer staples, consumer discretionary, financials, and healthcare are expected to post strong growth. EM issuance in first two months of 2023: Around $50 billion - Indicates strong liquidity and market access early in the year. January issuance share of annual requirement: About 20% - Typical amount EM issuers raise in January. Semiconductor cycle timing: Second half of 2022 destocking; early 2023 bottoming indicators - Explains the sector’s influence on EM equities.

Pivotal Quotes: "the quality of the earnings is going to be much better in 2023" — Alison Nathan (opening framing): Central thesis of the episode: earnings composition is improving even if headline growth is modest. "China reopening and the semiconductor cycle both are turning around make us much more positive on the EM equities for the next year" — Heron: Explains the main equity-positive catalysts after 2022’s underperformance. "the backdrop is much better looking forward than it was over the last year" — Kai: Summarizes why EM debt looks more resilient despite higher U.S. rates and a stronger dollar.

Implications: Investors should favor selective EM exposure over broad beta: higher-quality sovereigns, resilient corporates, India, and structural growth sectors. China reopening helps, but stock picking and balance-sheet quality matter more than ever.