Schroders Emerging Market Lens Q3 2023: how do valuations look mid-way through the year?
Your go-to guide to emerging markets brings you all the charts and data that matter.
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The EM Lens provides a snapshot of performance year-to-date, and looks at the latest valuation picture for EM equities and bonds.
Separate EM equity and debt chartbooks/presentations, packed full of data and insights, help you navigate the world of emerging markets. The aim here is to provide an unbiased top-down view of markets. Please note that the EM debt presentation is split into sections on hard currency debt, local currency debt, and currencies.
Download the full EM Lens packs here:
EM assets have registered gains year-to-date, despite global trade winds
Global macroeconomics continued to have an important impact on the outlook for and performance of EM assets in the first half of 2023. Ongoing uncertainty over the path of inflation led to false dawns around a peak in US rates. Firmer signs that EM inflation has peaked were welcome. This should provide space for EM rate cuts in the second half of the year, even if El Nino poses risks to the inflation outlook into next year.
Concern over the evolution of China’s economic recovery picked up through Q2, as macroeconomic data began to disappoint. This has led to speculation around stimulus measures in recent weeks, although Schroders’ economics team does not expect a major announcement, even if some targeted support may come through.
Against this backdrop both EM equities and bonds advanced. This was despite some easing in sentiment towards EM in Q2. Flows to EM equities remain positive year-to-date, but were flat versus Q1. EM bond market flows fell in Q2 and are now down year-to-date; however this masks a contrast between hard currency debt which has seen outflows and local debt which has seen inflows.
EM equities had a solid first half, but lag developed markets
Emerging market equities, as measured by the MSCI Emerging Markets Index returned close to 5% in the first half of 2023, lagging the MSCI World which was up just over 15%.
As we show below, China, which is the largest index market in EM, has been a drag. However, the stunning rally from the Super-7 stocks in the MSCI World has been a factor in the EM versus DM performance gap this year. The Super-7 are Apple, Microsoft, Alphabet (Google), Amazon, Tesla, Meta (Facebook), Nvidia.
The Super-7 have been the big winners YTD
Past performance is not a guide to future performance and may not be repeated. Super-7 portfolio is the seven largest companies in MSCI World by free float market capitalisation as at 31 December 2021. These are Apple, Microsoft, Alphabet (Google), Amazon, Tesla, Meta (Facebook), Nvidia. Source: Refinitiv Datastream, MSCI, Schroders Strategic Research Unit, as at 30 June 2023.
Year-to-date returns in EM equity markets, US dollar terms
Past performance is not a guide to future performance and may not be repeated. Percentage total return. US dollars. Source: Refinitiv Datastream, MSCI, Schroders Strategic Research Unit, as at 31 March 2023.
China is now one of the weakest EM equity markets year-to-date, down 5%. During the quarter the market briefly moved into a bear market (>20% decline) relative to the peak of its post-Covid re-opening rally, which started in late October. South Africa is also down year-to-date, despite some encouraging signs with regards to loadshedding (power blackouts) more recently.
Market return dispersion has been wide, with outperformers coming from all regions. Greece and Turkey book-end year-to-date performance. With elections over, Greece looks set on a path of ongoing reform. Meanwhile, following President Erdogan’s re-election, Turkey appeared to change policy course after new leaders were appointed in the finance ministry and central bank. The latter hiked rates by 6% in June, the first rate rise since early 2021. However, the required economic adjustment is only just underway.
The central European EM have also performed well, supported by currency strength amid easing inflation as lower energy prices feed through. Latin America is the best-performing region YTD, led by Mexico which has been aided by peso strength and optimism towards nearshoring.
Read more: Globalisation reset: which economies and markets stand to benefit?
1H EMD performance
Total return 1H 2023
*Local currency = US dollar for all apart from local EMD which is in the relevant local EM currency. Source: Schroders, Refinitiv Datastream, JP Morgan, Schroders Strategic Research Unit. Data as at 31 March 2023.1H 2023 EM currency returns versus US dollar (%)
EM bonds and currencies have generated positive returns year-to-date. This is despite a backdrop of ongoing pressure in developed market bond yields. In hard currency, both investment grade (IG) and high yield (HY) sub-indices have advanced, up 3.4% and 4.8% year-to-date.
Signs of a peak and subsequent fall in EM inflation across various economies were supportive. In local bonds, currency appreciation has boosted returns year-to-date.
In EM currencies, Latin American currencies have seen the most appreciation relative to the US dollar year to-date. Turkey and South Africa have seen the greatest currency depreciation.
Meanwhile, market access has remained a concern for high yield EM issuers. While total (sovereign and corporate) investment grade issuance is almost in line with the average over the past six years, for high yield the equivalent figure is just over 40%, and for high yield corporates below 30%.
1H 2023 EM currency returns versus US dollar (%)
Source: Schroders, Refinitiv Datastream. Data as at 30 June 2023.
What do valuations look like?
EM Equities
For EM equities, headline valuations at the overall level are mixed. On a price-to-earnings ratio basis, EM is just above the historical median (since 1995). The price-to-book ratio is close to the historical mean while on a dividend yield basis EM is cheap.
There continues to be a wide difference in sector valuations. Various higher price-earnings sectors are expensive versus history, notably health care. Meanwhile, Value’s discount to Growth is towards the top of its long-term range.
With the exception of India, and on certain measures South Korea, EM valuations at the market level remain reasonable though, as the heatmap below illustrates.
When compared with DM, EM equities are cheaper. While the degree of cheapness is less on a sector neutral basis, this gap has widened since the start of the year.
Average (trailing P/E, P/E, P/B, dividend yield) (z-score 1)
1The z-score is a measure of how far valuations are from historical mean, calculated since January 2000.Excludes UAE, Qatar, Saudi Arabia and Kuwait due to limited data history. Combined figure is an average of trailing P/E, 12-month forward P/E, P/B, and dividend yield. Source: Schroders, Refinitiv Datastream, MSCI, IBES, Schroders Strategic Research Unit. Data as at 31 March 2023.
EM bonds
At the headline level, hard currency spreads remain the cheapest versus their own history. However, it is worth digging beneath the headline figures.
Spread percentiles - Spreads of key EMD indices (basis points)
Source: Schroders, Refinitiv Datastream, J.P. Morgan. Data as at 30 June 2023. Spreads are adjusted for changes in the distribution of credit ratings within each index over time. Percentiles shows where the current spread is relatively to the historical range of spreads, within a range of 0 to 100. The greater the percentile the higher the spread compared to history. Hard EMD =stripped spread, Local EMD =Spread to five year UST, Corporate EMD = spread to worst.
Hard currency emerging market debt (EMD):
The spread dispersion between different markets is wide. This is attributable to the elevated spread on the high yield (HY) sovereign index. The spread on the investment grade (IG) sovereign market is below its historical average, and at a ten year low.
Local currency EMD:
The real yield premium of EM over DM is at the bottom-end of its post-GFC range. This is primarily due to the sharp decrease in EM real yields over the past 12 months, as inflation has increased by more than nominal yields. EM inflation is now falling though, and could provide some relief.
There are undervalued currencies in all three EM regions. The degree of value in EM currencies varies significantly.
Real exchange rate: deviation from average
Source: Schroders, Refinitiv Datastream, Schroders Strategic Research Unit. Data as at 30 June 2023.
Real exchange rate is the nominal dollar exchange rate deflated by the CPI of each EM country vs. US Long-term average is since January 1995.
Read all about it
More detailed analysis of EM equity and bond market valuations can be found in the dedicated EM equity and EM Lens packs. These are available via the links below, and include analysis of EMD issuance so far this year.
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