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Schroders Emerging Market Lens Q4 2023: how do EM equity and bond valuations look?

Schroders EM lens – your go-to guide to emerging markets

13/10/2023
Photo of Shanghai skyline

Authors

Andrew Rymer, CFA
Senior Strategist, Strategic Research Unit

The EM Lens provides a snapshot of year-to-date performance 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:

Emerging Markets Equity Lens

Emerging Markets Debt Lens

EM assets weathered a challenging Q3, amid a broader sell-off in global equities and bonds

An unstable global market backdrop, with concerns that US interest rates would be higher for longer, weighed on investor risk appetite in Q3. Fading momentum in China’s post-Covid economic revival also dragged on sentiment towards emerging markets (EM). The US dollar strengthened, which was negative for EM.

What to watch

Ongoing uncertainty in the global macroeconomic outlook continues to buffet EM assets. This is most evident in the impact from US dollar strength. US economic resilience and high interest rates continue to support the greenback, but confidence that policy has peaked could open the door to softness. Safe haven strength remains a risk.

Weaker EM earnings this year has not helped, but consensus expectations continue to anticipate a robust recovery in 2024, even if there is a risk of downward revisions. After a projected -4% fall this year, consensus EM earnings per share is forecast to rebound by 19% next year.

There are signs of an inflection in the inventory cycle, which would be favourable for EM exporters, and the technology cycle should improve into 2024. A DM recession could mute this rebound though.

Crude oil prices and El Nino are further areas to monitor. Oil moved above $90 per barrel in September, and while prices have since retreated, recent developments in the Middle East could affect the outlook. Permanently higher oil prices could drive a deterioration in the current account positions of net importers – the chart below shows the EM winners and losers from high fuel prices. Higher energy prices often pass-through to higher food prices. This is important due to the risk posed by El Nino, and as food has a large weight in EM inflation baskets.

Higher oil prices good for net exporters, bad for importers

EM-oil-importers-exporters

Source: LSEG Datastream, Schroders Economics Group. 15 September 2023.

EM equities are slightly positive in the year-to-date despite global pressure and China weakness

EM equities, as measured by the MSCI Emerging Markets Index, have registered modest year-to-date gains, at the end of Q3. China has been a drag since the middle of Q1, as illustrated by the relative outperformance of the MSCI Emerging Markets ex China Index. While both lag developed markets by some distance, as measured by the MSCI World Index, EM Small Cap is significantly outperforming. This is in part due to a lower China index weighting.

YTD EM and global equity market returns (USD)

EME-YTD

Past performance is not a guide to future performance and may not be repeated. Source: LSEG Datastream, MSCI, Schroders Strategic Research Unit, as at 30 September 2023. Total return, US dollars.

In terms of underlying EM market performance year-to-date, the return dispersion remains wide as shown below. Several EM Europe markets have delivered strong gains, in some cases influenced by stock specific factors; these are small markets in terms of the number of stocks. Latin America has been the best-performing region, led by Mexico where robust activity in the neighbouring US and nearshoring have provided support. More details on nearshoring and de-globalisation available here. Taiwan and South Korea are also ahead of the index year-to-date, with technology sector stocks pricing in some earnings rebound in 2024.  

YTD returns in EM equity markets, US dollar terms

EM-markets-YTD

Past performance is not a guide to future performance and may not be repeated. Source: Schroders, LSEG Datastream, MSCI, Schroders Strategic Research Unit. Data as at 30 September 2023. Note: EMEA is Europe, the Middle East and Africa.

Conversely, the EMEA and EM Asia regions have lagged wider EM in the year-to-date. In EMEA, South Africa has been the largest drag and is the weakest index market, almost wholly due to currency weakness. Given South Africa’s current account and fiscal deficits, ongoing rises in global interest rates have led the rand to depreciate versus the US dollar. Weaker industrial metals prices, and the domestic power crisis have not helped, despite signs of some easing in the latter. China remains behind the index year-to-date, though the gap has narrowed more recently.

EMD still positive year-to-date, led by local debt

EM bonds, both hard and local currency, have generated positive returns year-to-date, even if US high-yield edged ahead in Q3. This is despite a surge in developed market bond yields this year, with notable pressure over Q3. Additional monetary policy tightening from the Fed, together with concerns around US Treasury bond issuance, fed through to impact EMD.

Total return YTD

EMD-YTD

*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 30 September 2023.

In hard currency, gains have been generated by the high yield (HY) sub-index (+4.8%); the investment grade (IG) sub-index is negative (-1.1%) year-to-date. It is a similar picture in the corporate debt index. The HY Corporate sub-index is up 5.5%, while the corporate IG index has advanced just 1.9%.

Local bonds continue to lead EMD assets year-to-date. This is despite a rise in local yields in Q3, and US dollar strength, which took currency impact negative on a year-to-date basis.

EM currencies have registered a mixed performance versus the US dollar year-to-date. Most EM currencies came under pressure in Q3. As the chart below shows, Latin American currencies have been among the top performers so far this year. Turkey and South Africa have seen the greatest currency depreciation. 

Meanwhile, market access has remained a concern for HY EM issuers. This has been most pronounced among HY corporates. The issuance rate is just 31% of the average seen over the last six years.

Also worth flagging is the announcement from index provider JP Morgan during Q3 that it would begin to include India in its GBI-EM Global Bond indices from June 2024.

EM currency returns (%)

EM FX YTD

Past performance is not a guide to future performance and may not be repeated. Source: Schroders, LSEG Datastream. Data as at 30 September 2023.

What do valuations look like?

EM Equities

Top level EM equities valuations reflect a reasonable picture. EM equities are close to the historical median (since 1995) on a 12-month forward price-earnings. On a price-book measure EM is slightly below its historical median and is cheap versus history on a dividend yield basis.

There is wide variation in EM sector valuations, on a 12-month forward price-earnings measure. Healthcare stands out as notably expensive, as does IT. Industrials, utilities, and energy are close to the historical average.   

EM equities are cheap when compared with DM. The degree of cheapness is less on a sector neutral basis, but this gap has widened since the start of the year.   

At the individual market level, valuations are relatively cheap, except for India, and on certain measures South Korea. This is illustrated in the heatmap below.

Average (trailing P/E, P/E, P/B, dividend yield) (z-score 1)

EME-valuations.emf

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 30 September 2023.

EM bonds

In EMD, headline valuations point to hard currency spreads as cheapest versus their own history. This is in part due to index composition changes over recent years.

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

EMD-valuations

Source: Schroders, Refinitiv Datastream, J.P. Morgan. Data as at 30 September 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 sovereign EM bond index yield and spread are elevated relative to their long-term history. The above-median spread is driven by the high yield (HY) sovereign index. The spread on the investment grade (IG) sovereign market is below its historical average and continues to hover around 15-year lows. This has been driven in part by index composition changes over recent years, with the higher rated Gulf markets added in 2019.

Local currency EMD:

The real yield premium of EM over DM has hit a new post-GFC range low. This is primarily due to rising DM real yields over the past few months. The average local EM yield curve is slightly upwardly sloping.

There are undervalued currencies in all three EM regions. The degree of value in EM currencies varies significantly.

Real exchange rate: deviation from average

FX-valuation

Source: Schroders, Refinitiv Datastream, Schroders Strategic Research Unit. Data as at 30 September 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 Debt 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

Topics

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