Emerging Markets Insights: Easier financial conditions in emerging markets

Interest rate cuts and changing trading patterns bode well for emerging markets, according to the Franklin Templeton Emerging Market Equity Report. Get the latest team predictions.

Three things we’re thinking about today

1. Earnings: Consensus forecasts indicate earnings growth of 18%. For the MSCI Emerging Markets Index in 2024, which compares to expectations of a 9% contraction in 2023.¹ Expectations for next year have remained steady since recent months. China, Taiwan and Mexico pushed down expectations for this year. Looking ahead, recoveries in South Korea, Taiwan and China are expected to drive the recovery in 2024, with the technology sector being the main driver.
2. China’s real estate measures target demand: Tier 1 cities in China are cutting mortgage payments for second homes to 40% from 70-80%.² Shenzhen is the second city after Guangzhou to implement the change. This follows Similar down payments for primary homes reduced to 30%-35% earlier this year.³ Policies on home value ranges, which also affect down payments, have been lifted in tier-I cities. The changes are aimed at increasing housing affordability and demand.
3. Weakness of the US dollar: A faster-than-expected decline in inflation and dovish comments on interest rates by US Federal Reserve Governor Christopher Waller pushed bond yields and the dollar lower in November. The US currency has declined by 3.4% since its highest levels in October.⁴ A weaker US dollar creates easier financial conditions in emerging markets, as central banks do not need to use interest rates as a tool to support the local currency. A depreciation of the US currency also reduces the cost of foreign currency debt in local currency terms. This reduces the financing burden on companies in emerging markets.

Prospects

Franklin Templeton’s emerging markets equity team visited China in November to assess the situation on the ground. We conducted field visits and conducted interviews with management in selected companies. The majority of the team members came out of this trip with a positive outlook after the visit.

We had some pleasant surprises. The recent tightening of US restrictions has made headlines, but during our visit, we realized that companies with dealings outside China are somewhat insulated from these restrictions:

• A medical device manufacturer revealed that it was easy to switch to an FDA-approved factory outside China. This was in response to concerns from its US-based customers about sourcing from China.
• Not all technology companies in China will be affected by the CHIPS Act.⁵ Examples include companies operating in the electric vehicles, scanning and consumer electronics sectors. These companies only require standard chips, and these chips can be obtained locally as China already has experience with them.

We have also witnessed the speed of technological progress in China. For example, a food delivery platform uses drones to deliver food in crowded urban neighborhoods. In developed markets, progress in drone delivery has been limited at best.

Elsewhere, interest rate cuts and changing trade patterns bode well for emerging markets. Interest rate cuts reduce financing costs and are therefore positive for companies.

This would boost profits and stimulate investments, which would boost the global economy. However, while banks’ net interest margins may face some pressure, credit growth may follow.

The increasingly popular China+1 strategy⁶ It is also expected to benefit India, Mexico and several ASEAN economies. This strategy also helps reduce supply chain risks and allows other economies to grow.

What concerns us is the upward outlook of the investment landscape in emerging markets. There are still many companies with long-term earnings power in the investment world.

Some examples of such companies are discussed above. Our field teams are equipped with access to company management, which is critical to our evaluation.

Market Review – November 2023

Emerging market stocks rose during the month but lagged their developed market counterparts. Markets reacted well to the US Federal Reserve’s move to keep interest rates steady. The latest US inflation reading was better than expected and showed signs of decline.

This helped the stock’s performance. During the month, the MSCI Emerging Markets Index returned 8.02%, while the MSCI World Index advanced 9.43%.⁷

Emerging Asia saw a turnaround in November, recovering from the previous month’s losses. Wall Street’s tech rally extended to South Korea and Taiwan, fueling gains for chip stocks in those two countries. South Korean stocks rose after a short-selling ban was implemented. Stocks affected by previous short selling have reaped the benefits of this reversal.

Lower oil prices helped Indian stocks advance. A favorable court decision in response to the short-seller report earlier this year pushed up market returns – and the market interpreted this as a lack of evidence in the allegations against the Adani Group (not portfolio holdings).

Stocks in China also performed well. The stimulus program and easing tensions between the US and China helped market sentiment. Chinese property stocks rebounded from policy support. However, Alibaba (BABA) stock price fell and gains were limited.

Disappointing second-quarter earnings and the suspension of the initial public offering of its cloud and grocery arms weighed on its stock price. News that co-founder Jack Ma’s initial plans to reduce his stake in the company also sent the stock lower.

Stock markets in the emerging EMEA region also rose. Middle East stock markets benefited from a brief rebound in oil prices later in the month on the back of potential supply cuts.

Other countries saw a difference in monetary policy. While the Central Bank of Egypt kept interest rates constant, the Hungarian Central Bank lowered interest rates and Turkey chose to raise interest rates.

Latin American stocks performed well. The Brazilian Central Bank cut interest rates for the third time in a row.

Shares of the state-run oil company and its largest utility rose – the former with a raise in its production forecasts and a dividend announcement, and the latter thanks to a better-than-expected net profit in the third quarter.

The Mexican market benefited from further easing of inflation. The government also approved a draft law to enhance trading on national stock exchanges.

What are the risks?

All investments involve risks, including possible loss of principal.

Money bills Subject to price fluctuations and possible loss of capital.

International investments are subject to special risks Including currency fluctuations and social, economic and political uncertainties, which can increase volatility. These risks are magnified in emerging markets. Investments in companies in A A specific country or region They may experience greater volatility than those that are more geographically diverse.

Government participation in the economy remains high, therefore, Investments in China You will be subject to greater levels of regulatory risk compared to many other countries.

There are special risks associated Investments in China, Hong Kong and TaiwanIncluding low liquidity, property expropriation, confiscation taxes, international trade tensions, nationalization, exchange control regimes and rapid inflation, all of which could negatively impact the Fund. Investments in Taiwan may be negatively affected by its political and economic relationship with China.

Any companies and/or case studies referenced herein are used for illustrative purposes only; Any investment may or may not be currently held through any portfolio advised by Franklin Templeton. The information provided is not an individual investment recommendation or advice for any particular security, strategy or investment product and is not an indication of trading intent for any portfolio managed by Franklin Templeton.

1. Source: Bloomberg. As of November 22, 2023. There is no guarantee that any estimate, forecast or forecast will be met.

2. Source: E-House Enterprise Group.

3. Ibid.

4. Source: Bloomberg. As of November 30, 2023.

5. The CHIPES Act prohibits funding recipients from expanding semiconductor manufacturing in China and countries determined by U.S. law to pose a threat to the national security of the United States.

6. The China+1 strategy refers to the long-term structural trend in which global manufacturers establish an additional overseas production base in China as well as another country.

7. The MSCI All Country World Index is a market capitalization-weighted, free-float-adjusted index designed to measure stock market performance in global developed and emerging markets. The MSCI Emerging Markets Index is a free-form, market-cap-weighted equity index designed to measure equity market performance in global emerging markets. Indices are unmanaged and one cannot invest in them directly. It does not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

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Editor’s note: The summary points for this article were selected by Seeking Alpha editors.