Outlook: The Case For Emerging Markets

Jan 2023

Emerging market investors have witnessed troubled waters over the past few years: a global pandemic that had a negative impact on trade, consumption, and supply chains; increased geopolitical tensions between the US and China; a war in Europe with wide ramifications for global trade and fiscal policies resulting in rising inflation, tighter monetary policy, and appreciation of the US dollar. Furthermore, volatile commodity prices that benefitted a few countries but hurt many, and very difficult capital market conditions made it particularly difficult for emerging markets. In summary, all of this has led to very low confidence, record capital outflows, and a sell-off of the asset class. Over the last 10 years, emerging markets have delivered close to negative real returns on an annualised basis. After this prolonged period of weak performance, we now see several indicators suggesting that the tide is turning.

Valuations at a Record Low

Investors should never lose sight of valuations. At the moment, we are witnessing record-low valuation levels in EM — the current average price-to-book value at nearly 1.5x is in the 30-year bottom quartile. The current P/E and EV/EBITDA market valuation indicates that emerging markets are trading at the largest discount to developed markets since 2008. At the same time, many emerging market currencies are currently undervalued.

Source: Bloomberg, as of 03 January 2023

Inflation and Monetary Easing

Inflation pressure in the US is moderating. Inflation declined to 6.5% in December compared with a year earlier, down from 7.1% in November. The slowing pace in inflation is a clear indicator that the Fed’s rate-hiking cycle is nearing its peak and monetary policy is expected to ease. Many emerging markets are ahead of developed markets in the hiking cycle and inflationary pressure, especially in Asia, remains contained. Developed markets saw an inflation increase from around 1% to around 7% on average, while inflation in Asia averages around 4%.

Highly Innovative Businesses in EM

Over the past 20 years, business models in emerging markets have significantly evolved. Investors can find highly innovative companies with unique business models led by excellent management teams that are still relatively undiscovered by the market, and currently most certainly under-owned. The new driver in emerging markets is technological innovation in areas including, but not limited to, factory automation, autonomous driving, renewable energy, AI or Internet of things (IoT), as well as digitalisation and modern and efficient service offerings. We are particularly interested in companies with predictable and stable recurring revenue streams and stable margins, for example in the software development industry.

Ever-growing Consumption and Faster Real Wage Accretion

a Favourable demographic dynamics and urbanisation in emerging markets remain structural tailwinds for the long term. The middle class in emerging economies is younger, increasingly more educated, and has demonstrated accelerated adoption of oechnology. The macroeconomic growth, combined with technological innovation, has yielded higher wage growth and disposable income in these countries. This in turn will result in higher spending and boost domestic consumption. For example, Taiwan and South Korea are expected to jump ahead of Japan in terms of GDP per capita in 2022–23.

Corporate Earnings Recovery

The corporate earnings recovery will be driven by the reopening in Asia. The average EPS growth forecast over three years annualised (CAGR) for the MSCI EM Index is 13% and for MEMF’s portfolio 15%.

Source: Bloomberg, BEst LTG EPS as of 30 December 2022

US Dollar Rally Losing Steam

The US dollar rally is losing steam on the back of favourable inflation data, easing the pressure on emerging market currencies, debt, and monetary policy.

Source: Bloomberg, as of 05 January 2023

Relaxation of Chinese Zero-Covid Policy

Chinese economic activity — that is, consumption, trade, and mobility of its population — has been radically weakened during “zero-Covid”. Now, for the first time in years, there are clear signs that China is relaxing its zero-Covid policy which will have a very positive impact on growth and supply chains. We must be mindful and prepare for a stony path to the recovery. Exports this year could be negatively impacted by weak demand from the EU and the US, booster rates among the elderly in China remain very low and the desire to reach herd immunity can take time. However, a post-pandemic recovery in China will not only serve as a domestic impulse, but positively affect all countries which trade with China, particularly in Asia.

Source: Bloomberg, Mobius Capital Partners LLP, S&P Capital IQ, IMF, National Bureau of Statistics of China, World Economic Outlook Database October 2022, CNN


We have heard many differing opinions about what investors can expect from the coming year. We share the view of Neil Armstrong that, “We predict too much for the next year and yet far too little for the next ten.” And one longer-term prediction continues to hold true: a recovery is still to come. A recovery not from one bad year, but a recovery from a pandemic of an unprecedented scale,- at least in living memory. As always, markets will price this in first. We have already seen a gradual reversal of fund flows back into emerging markets.

Source: Bloomberg

At Mobius Capital Partners, we continue to focus on the long-term potential of our companies which are catering to growing trends like digitalisation, quality health care, factory automation, and renewable energy and on creating long-term, sustainable shareholder value for our investors.