Schroders Emerging Market Lens Q3 2024: your guide to EM valuations
After a solid first half of 2024, and with a packed EM election agenda over, how do EM asset valuations look?
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Emerging market (EM) stocks and bonds, with the exception of local currency debt, delivered solid gains in the first half of 2024. This was despite EM currencies losing value almost across the board, in the face of further US dollar strength.
Ongoing resilience in global growth, underpinned by the United States, has contributed to a further pickup in the global goods cycle. This is supportive of EM exporters, and Schroders’ economists anticipate that the upturn in the manufacturing cycle should extend into 2025.
Several EM central banks in Latin America and EM Europe loosened monetary policy in the first half of the year. However, the marked adjustment in Federal Reserve (Fed) monetary policy expectations from the start of 2024 has led the dollar to strengthen. This dynamic raises questions over the extent of EM easing cycles. In EM Asia, some central banks have paused or raised rates to protect their currencies.
A busy EM election agenda in the first half of the year has now passed. Results were mixed, leading to a pickup in market volatility in late May/early June post-election results in South Africa, India, and Mexico.
Read more: What should investors make of this year’s emerging market election results?
In this edition of the EM Lens we review the performance trends and drivers of EM stocks and bonds in the first half of the year, and assess valuations.
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.
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How did EM stocks perform in the first half of the year?
EM equities returned 8% in the first half of the year but underperformed developed markets (DM). However, this was driven by ongoing US exceptionalism; EM is now top of the chasing pack year-to-date as at 30 June 2024.
Calendar year returns of major indices (USD)
Past performance is not a guide to future performance and may not be repeated. Total return, USD. Source: LSEG Datastream, MSCI, Schroders Strategic Research Unit, as at 30 June 2024.
Among the large index markets, Taiwan (+30%) and India (+17%) have generated the strongest gains year-to-date; conversely Brazil (-19%) and Mexico (-15%) lag, with elections a factor in the latter. China had moved ahead of EM on a year-to-date basis during Q2 but fell back after weakness in June.
EM index performance concentration has been somewhat narrow at sector and stock level. IT, which is the largest sector by index weight, has been the major driver of returns; IT has delivered more than double the return of any other EM sector, as excitement around AI continues. This extends a trend in place since early 2023; momentum remains the best-performing factor year-to-date.
EM market cap weighted index outperforming equal weighted – a sign of performance concentration
Past performance is not a guide to future performance and may not be repeated. Total return, US dollars. Source: LSEG Datastream, MSCI, Schroders Strategic Research Unit, as at 30 June 2024.
EM elections in markets totalling over 50% of the MSCI Emerging Markets index were held in the first half of the year. While some uncertainty naturally lingers on, the outcomes in the largest EM were neutral to positive from a market perspective.
How did EM bonds perform in Q1?
So far this year, EM corporate debt has outperformed, with total returns from hard currency sovereign also positive. Conversely, local EM debt remains in negative territory, owing to US dollar strength.
Year-to-date, 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 30 June 2024.
Underlying the headline hard currency EMD returns, there remains significant divergence between sovereign high yield (HY) (+5.2%) and investment grade (IG) (-0.5%) sub-index performance. Within HY, Ecuador (+46%, Argentina (+31%) and Pakistan (+31%) have been among the strongest markets, despite some weakness in the past month. In corporate hard currency EMD, the trend is similar with HY comfortably outperforming IG.
By contrast, local EM debt remains in negative territory, owing to US dollar strength. Latin America has been the main area of weakness year-to-date, notably Brazil but also Mexico and Chile. EM currencies have experienced broad depreciation versus the dollar so far this year.
EM FX broadly weak YTD to end June vs. US dollar
Past performance is not a guide to future performance and may not be repeated. Egyptian pound (-36%) not shown). Source: Schroders, LSEG Datastream. Data as at 30 June 2024.
What do valuations look like?
Equities
The consensus expectation for EM earnings growth has increased to 21% and 15% year-on-year for 2024 and 2025 respectively; for 2024 the figure is double that of the US. From a valuation angle, various headline measures are modestly above the historical average, but this is skewed in part by high valuations in certain large markets.
Aggregate valuations are modestly above the historical median on 12-month forward price-earnings (P/E) and price-book (P/B) measures, and slightly cheap on dividend yield.
Most EM are cheap versus their own history, using a standardised composite valuation measure, as the heatmap below illustrates. Meanwhile the -34% valuation discount to DM remains close to its highest level in 20 years.
EM valuation heatmaps – only a few markets are expensive versus history, but these are large and skew the index average
EM valuation heatmaps – 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 30 June 2024.
Bonds
At the headline level, EMD spreads are slightly above their historical median in hard currency EMD, and below in corporate EMD and local EMD.
In hard currency sovereign EMD, the IG sub-index spread is below the historical median and has continued to fall so far this year. By contrast, the HY spread, having fallen to its historical median during the first half of the year, is now higher than it started 2024. This is still well below the peak seen in late 2022.
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 line with its historical median.
With regards the tight valuation of the IG sub-index, it is worth highlighting the impact of compositional change. Specifically, the impact of the rise in index weight of the Middle East, which is higher rated and has impacted the valuation picture.
Sovereign EMD regional split
Source: LSEG Datastream, JP Morgan. Data as at 30 June 2024. IG sub-index is 49.7% of JP Morgan EMBIG Diversified Index.
In local EMD, real yields are positive almost across the board, having picked up materially since the start of the year. This has been driven by a rise in bond yields so far this year, coupled with ongoing disinflation. Latin America offers some of the highest real yields, notably Brazil, Mexico, and Peru. Taiwan is the exception here.
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 30 June 2024.
Another point to highlight is that net credit rating changes have turned positive on a 12-month moving average bass. This is only the second occasion in the past decade.
Sovereign hard currency index net credit rating upgrades/downgrades
Past performance is not a guide to future performance and may not be repeated. Weighted by number of issuers, not size of issuer. Source: Schroders, Bloomberg. Data as at 30 June 2024.
There are undervalued currencies in all three EM regions, but the degree of value varies significantly…
The Czech koruna, Uruguayan peso, and to a lesser extent Romanian leu and Polish zloty, are above their long term and five-year averages. Conversely, Turkey, Brazil, Malaysia and South Africa, are among the cheapest EM currencies relative to the long-term average.
Some currencies are significantly undervalued
Real exchange rate: deviation from average
Source: Schroders, LSEG Datastream. Data as at 30 June 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, and the timing of expected Fed rate cuts remains key. November’s US presidential election is also important to the EM outlook, given implications for US rates, the path of the dollar and foreign and trade policy. It is early days in the election campaign, and this issue could capture market focus in the coming months.
The macroeconomic and policy outlook in China is a further area to monitor. On the geopolitical front, US-China trade relations, Russia’s invasion of Ukraine and the conflict in the Middle East present additional risks. These have the potential to impact energy and food prices and 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.
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