Schroders Emerging Market Lens Q1 2025: your guide to EM valuations
As EM investors await Trump 2.0 policy details, and amid the risk of trade tariffs, we review 2024 performance and unpack valuations.
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Emerging market (EM) equities and debt, with the exception of local bonds, delivered positive returns in 2024. This was despite headwinds from a stronger US dollar, global trade and broader geopolitical concerns, as well as ongoing negative sentiment, notably towards EM debt where net outflows have persisted since 2022.
In this edition of the EM Lens we review the performance trends and drivers of EM stocks and bonds in 2024, and assess valuations. The lens includes separate EM equity and debt chartbooks/presentations, packed full of data and insights, to help you navigate the world of emerging markets. The aim here is to provide an unbiased top-down view of markets.
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How did EM equities perform in 2024?
EM equities returned 8% in US dollar terms, but lagged developed markets (DM), which rallied 19%, with US dollar strength a headwind. The DM return was underpinned by strong US equity (+25%) performance; EM outperformed World ex US.
2024 calendar year performance (USD)
Source: LSEG Datastream, MSCI, Schroders Strategic Research Unit, as at 31 December 2024. All returns rates shown in USD terms. Please see relevant disclaimers on page 45. Past performance is not a guide to future performance and may not be repeated.
Underlying the headline EM equity return was a wide dispersion in market returns. Taiwan (+35%) was the strongest index market. China rallied 20%, outperforming EM and (marginally) DM for the first calendar year since 2020. The government announced a policy pivot in September, deploying monetary easing, which together with hopes for fiscal stimulus supported a strong equity market rally.
Conversely, South Korea, Brazil and Mexico lagged, with negative returns amplified by currency weakness. EM saw key elections totalling over 50% of the MSCI Emerging Markets index last year. Election results in the largest markets by market capitalisation, India and Taiwan, were neutral/positive for investors, with some lingering uncertainty in markets such as Mexico and South Africa.
Various EM sectors posted double digit returns in US dollar terms last year. IT, which is the largest sector in the MSCI Emerging Markets Index, led performance. However, only real estate, a tiny sector, outperformed its DM equivalent. From a style perspective, momentum continued to lead the way in EM, with EM growth outperforming by a smaller margin.
EM performance has been concentrated in recent years, as measured by the outperformance of the market cap weighted EM index over the equal weighted EM index. This trend turned in September, amid a broad rally in China.
EM market cap weighted index/equal weighted monthly returns – a measure of performance concentration
Source: LSEG Datastream, MSCI, Schroders Strategic Research Unit, as at 31 December 2024. US dollars, total return. Please see relevant disclaimers on page 45. Base = 31 December 2019. Past performance is not a guide to future performance and may not be repeated.
How did EM bonds perform in 2024?
Hard currency emerging market debt (EMD) posted a consecutive year of strong performance, as spreads continued to tighten. This was despite weakness in Q4, amid rising Treasury yields, US dollar strength, and global trade concerns following Donald Trump’s US election victory.
Local EMD fell 2.4% in US dollar unhedged terms in 2024, negatively impacted by EM currency depreciation. This was after a tough Q4 which saw local debt lose 7% amid a combination of rising external concerns and a strong dollar, as well as domestic concerns in certain EM such as Brazil.
2024, total return (USD)
Past performance is not a guide to future performance and may not be repeated. Note: Local currency = US dollar for all apart from local EMD which is in the relevant local EM currency. Source: Schroders, LSEG Datastream, JP Morgan, Schroders Strategic Research Unit. Data as at 31 December 2024.
Hard currency sovereign and corporate EMD returned 6.5% and 7.6% respectively, with gains underpinned in both cases by the high yield (HY) sub-indices. The top 10 performing hard currency sovereign markets in 2024 were all high yield, with the weakest performers mainly investment grade (IG). Hard currency spreads tightened for a consecutive calendar year and are now below the historical median for sovereign and corporate HY and IG sub-indices.
In local EMD, currency depreciation was the main headwind, as the chart below illustrates, especially in the final quarter of the year. Local Latin American bond markets, notably Brazil (-22%) and Mexico (-16%) recorded the weakest performance; by contrast South Africa (+14%) was the best performing index market.
Most EM currencies depreciated versus the US dollar in 2024
EM FX performance versus US dollar 2024 (%)
Past performance is not a guide to future performance and may not be repeated. Source: LSEG Datastream, MSCI, Schroders Strategic Research Unit, as 31 December 2024.
What do valuations look like?
Equities
EM earnings growth expectations are projected to be relatively strong vs. global peers in 2025/26, based on consensus numbers. Earnings per share growth of 14% and 12% is anticipated this year and in 2026 respectively.
At the headline level, EM equity valuations are not significantly extended or cheap versus history. Valuations are close to or slightly above the historical median on price-book (P/B), 12-month forward price-earnings (P/E), and dividend yield measures.
However, India and Taiwan skew the aggregate, and a large number of individual EM are cheap versus their own history, using a standardised composite valuation measure, as the heatmap below illustrates.
Current Z-scores¹
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 31 December.
Meanwhile, the valuation gap to DM remains close to its widest in 20 years, at a 38% discount. When compared to the US, EM’s discount is now 47% - it was 26% at the time of Trump’s 2016 election victory.
Bonds
Hard currency spreads tightened for a consecutive calendar year and are now below the historical median for sovereign and corporate HY and IG sub-indices. However, the extent of spread tightness varies by region, as the chart below with regional spreads for hard currency sovereign debt illustrates.
Spreads for most regions are at or below the historical median
Spreads of key regional hard currency EMD indices (basis points)
Past performance is not a guide to future performance and may not be repeated. Asia region spread tightened significantly in December after restructuring of previously defaulted Sri Lankan bonds. Source: Schroders, LSEG Datastream, ICE Data Indices, JP Morgan. Data as at 31 December 2024.
In local EMD, real yields are positive across the board, and notably so in Latin America. Real yields have increased after the monetary policy tightening over the last few years, and as inflation subsided.
Real 10-year yield
Nominal 10-year yield minus annual headline or core inflation. Turkey’s real 10-year yield omitted from the figure. Source: Schroders, LSEG Datastream. Data as at 31 December 2024.
On a weighted average basis by index market, the average EM real yield premium to DM has continued to trend higher, reaching 3.1% at the end of 2024.
Real yield differential continued to trend higher in 2024
EM-DM real yield differential (%)
Past performance is not a guide to future performance and may not be repeated.
EM real yield is weighted average of individual JPM GBI-EM index nominal yields deflated by core inflation. DM real yield is 5Y government bond yields of US, UK, Euro zone, Japan deflated by core inflation, weighted by the size of individual government bond market. Source: Schroders, LSEG Datastream, ICE Data Indices, JP Morgan. Data as at 31 December 2024.
There are currencies which appear undervalued in all three EM regions, but the degree of value varies significantly…
The Czech koruna is notably above its long term, and to a lesser extent, five-year averages on a real exchange rate basis. The Indian rupee, Uruguayan peso, Romanian leu, and Polish zloty are also above their long-term averages on a real exchange rate basis. The Brazilian real, Turkish lira, and South African rand rank as cheapest relative to their long-term averages.
Some currencies appear significantly undervalued relative to their long-term average
Real exchange rate: deviation from average
Source: Schroders, LSEG Datastream. Data as at 31 December 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 direction of policy under the incoming Trump administration remains key, given implications for growth and inflation, US bond yields and the dollar. The US economy remains strong and there is a risk that Trump’s policy agenda leads to sticky inflation, limiting the headroom for the US Federal Reserve to loosen monetary policy, and providing support to the dollar. Trump’s inauguration takes place on 20 January after which greater detail may follow.
Read more: What if Trump isn’t bluffing?
Allied to the policy outlook is the risk of potential trade tariffs. Schroders economics team anticipates a more pragmatic pro-growth policy mix, relative to some campaign trail rhetoric. However, aggressive trade tariffs remain an ongoing risk. Foreign policy more broadly will be important, including the US relationship with China, the strategy to end Russia’s invasion of Ukraine, as well as the approach to the conflict in the Middle East.
Video: China, the US and the implications of Donald Trump’s return to the White House
On the other hand, the potential for further policy support in China, specifically fiscal stimulus, is a further watchpoint for investors after the enthusiasm from markets last September. This presents potential upside risk for EM. The global trade cycle, and technology cycle are additional drivers to monitor.
Read more here…
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.
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