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Schroders Emerging Market Lens Q2 2024: your guide to EM valuations

How did EM assets perform in Q1 2024, and what do valuations look like going into Q2?

12/04/2024
Hong Kong

Authors

Andrew Rymer, CFA
Senior Strategist, Strategic Research Unit

Emerging market (EM) stocks and bonds delivered positive returns in Q1 2024. This was against a backdrop which saw continued resilience in global growth, underpinned by the US, where expectations for a ‘soft landing’ picked up.

Sentiment towards EM was mixed, and at the market flow level, there was clear divergence between EM equities and bonds. The trends seen in 2023 persisted, with EM equities receiving small positive inflows over Q1, whilst EM bonds saw firm net outflows, split between hard currency and local EM bonds.

In this edition of the EM Lens we assess the performance and drivers of EM stocks and bonds in Q1, and take stock of valuations as we head into Q2.   

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.

Download the full EM lens packs here:

Emerging Markets Equity Lens

Emerging Markets Debt Lens

How did EM stocks perform in Q1?

EM stocks returned 2.4% in US dollar terms in Q1, but lagged developed markets (DM), which advanced 9%. Robust US economic data rekindled the prospect of "higher for longer" US rates, with associated US dollar strength a headwind for EM assets.

Various performance trends from last year have persisted into 2024, notably divergent US-China market performance, and outperformance from the IT sector, amid ongoing enthusiasm towards Artificial Intelligence (AI); momentum is the best-performing factor.

2024 YTD equity market returns (USD)

EN

Past performance is not a guide to future performance and may not be repeated.

Total return, USD. Source: Schroders, LSEG Datastream, MSCI, Schroders Strategic Research Unit. Data as at 29 March 2024.

Although Q1 remained a challenging period for EM versus DM performance, there were some signs of a pick-up in China, following some initial weakness in January. The question is whether the rally will have legs? Valuations for the MSCI China are in aggregate cheap, while forecast earnings growth for this year and 2025 are 14% for each year. There are also growing signs of improvement in the outlook for the external sectors of the economy. Set against this are the ongoing challenges of weak domestic growth, policy uncertainty, and geopolitics.

Looking within the EM headline return, performance dispersion by market remains wide. The range of returns in US dollar terms stretched from -30% in Egypt to 15% in Colombia. This only emphasises the heterogeneity of the emerging market investment universe, and the importance of maintaining a close eye on the different market dynamics. 

YTD returns in EM equity markets (USD)

EN

Past performance is not a guide to future performance and may not be repeated.

Note: EMEA is Europe, the Middle East and Africa. World is developed market only. Total return, USD. Note that Peru has not been shown due to data concerns which we are investigating with LSEG Datastream. Source: Schroders, LSEG Datastream, MSCI, Schroders Strategic Research Unit. Data as at 29 March 2024.

How did EM bonds perform in Q1?

EM bonds registered mixed performance in Q1. Sovereign and corporate hard currency bonds delivered solid gains. Meanwhile local debt lost value due to currency weakness.

Hard currency sovereign emerging market debt (EMD) returned 2% in Q1, extending the strong performance witnessed in 2023. However, the headline hard currency return masked divergent high yield (HY) (+4.9%) and investment grade (IG) (-0.8%) sub-index performance. The IG sub-index was negatively impacted by rising US bond yields over the quarter. Within HY, performance has been led by Ecuador (+52%), Pakistan (27%), Argentina (+26%) and Egypt (+22%).

Hard currency sovereign bonds, year-to-date total return (USD)

EN

Past performance is not a guide to future performance and may not be repeated. Source: Schroders, LSEG Datastream, JP Morgan, Schroders Strategic Research Unit. Data as at 28 March 2024.

It was a similar picture in hard currency corporate debt, with the headline index advancing 2.3%. The underlying IG and HY sub-indices returned 1.0% and 4.1% respectively.

Meanwhile, local currency EM bonds fell 2.1% in Q1, with US dollar strength the key drag. Chile and Turkey, where the peso and lira were firmly down, were among the weakest index markets. The Uruguayan peso and Mexican peso have been firmer year to date. For the Mexican peso this is a continuation of strength seen last year on the back of high real rates, a more hawkish central bank, firm economic performance, and amid ongoing optimism towards nearshoring.

Read more: Globalisation reset: which economies and markets stand to benefit?

EM Q1 currency returns (%)

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Past performance is not a guide to future performance and may not be repeated. Source: Schroders, LSEG Datastream. Data as at 29 March 2024.

What do valuations look like?

Equities

The consensus earnings outlook for EM projects growth of 20% this year, and 16% in 2025. These figures are ahead of other major markets. The underlying valuation picture is more nuanced though.

EM equity valuations are slightly above the historical median on 12-month forward price-earnings (P/E) and a price-book (P/B) measure, but cheap on dividend yield.

However, relative to DM, the EM discount is now close to the largest seen over the last 20 years on a 12-month forward P/E basis. Indeed, the discount to the US market is now 44%.

EM equities are cheap compared to DM equities

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Source: LSEG Datastream, MSCI, IBES, Schroders Strategic Research Unit. Data as at 29 March 2024.

On a standardised composite valuation measure most EM markets ex India, and on some measures South Korea, are cheap versus their own history.

Most of EM is cheap but the degree varies

EM valuation heatmaps – current z-scores¹

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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, LSEG Datastream, MSCI, IBES, Schroders Strategic Research Unit. Data as at 29 March 2024.

Bonds

At the headline level, illustrated below, EMD spreads are below their historical average.

The hard currency sovereign EMD index spread moved below its historical median in Q1. This was driven by spread compression in the HY sub-index, which is now in line with its historical median.

The IG sub-index remains well below its historical average, and at a more than 15-year low. This has been driven in part by index composition changes over recent years, with the higher rated Gulf markets added in 2019.

EMD headline valuations

Spread percentiles - Spreads of key EMD indices (basis points)

EN

Source: Schroders, LSEG Datastream, J.P. Morgan. Data as at 28 March 2024. Percentiles shows where the current spread is relative 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 5 year UST, Corporate EMD = spread to worst.

Sovereign EMD spreads have trended down since Q4 2022, primarily driven by the HY component, but dispersion between countries remains wide. This is evident at the regional level; despite its small size, Africa is the second largest contributor to spread after Latin America.

Spreads of key regional hard currency EMD indices (basis points)

EN

Past performance is not a guide to future performance and may not be repeated. Percentiles shows where the current stripped 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.

Source: Schroders, LSEG Datastream, ICE Data Indices, JP Morgan. Data as at 29 March 2024.

There are undervalued currencies in all three EM regions, but the degree of value varies significantly…

Turkey, South Africa, Malaysia and Chile have real exchange rates below both the five-year and long-term average, and are among the cheapest currencies. Conversely, currencies in the Czech Republic, Uruguay and Romania are above their long-term averages. The Mexican peso and Polish zloty are also above their long-term averages, and notably so versus their five-year average.

Some currencies are significantly undervalued

Real exchange rate: deviation from average

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Source: Schroders, LSEG Datastream. Data as at 28 March 2024. Real exchange rate is the nominal dollar exchange rate deflated by the consumer price index (CPI) of each EM country vs. US. Long-term average is since January 1995.

Risks to monitor for EM

The outlook for US growth, inflation, the prospect for Federal Reserve rate cuts, and the US dollar remain key for EM assets. Developments in China on the policy front are also important to monitor.

Geopolitical risk is inherent in EM investing, but this is a heavy election year which naturally adds to uncertainty. So far, domestic EM electoral cycles have not provided any major negative surprises. With EM elections remaining in India, Mexico and South Africa, it is the latter South Africa where the outcome appears most uncertain.

However, it may be an election outside of EM, in the US, which is most important for the remainder of this year. Not least given implications for the path of the US dollar, but also for foreign policy. Long term strategic competition between the US and China has led to ongoing tensions in recent years.

Russia’s invasion of Ukraine and the current conflict in the Middle East are further watchpoints, with global significance. These have potential to impact energy prices, and higher crude oil prices could pose a risk to inflation.

Read more here…

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.

Emerging Markets Equity Lens

Emerging Markets Debt Lens

Authors

Andrew Rymer, CFA
Senior Strategist, Strategic Research Unit

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