Emerging Markets: December quarter shows

positive signs after a challenging 2022

Pendal

January 2023

IT was a difficult year for emerging equity markets in 2022, but the December quarter was more positive despite ongoing growth and inflation pressures in key economies.

Last year Russia's invasion of Ukraine drove prices of key commodities sharply higher in an environment where inflation was already high and the outlook for interest rates was difficult.

This was combined with ongoing economic weakness in China.

The MSCI EM Index returned -20.1% in USD terms.

Here is a recap of the main EM themes in 2022 and what we learned in the closing months of the year.

Russia

In Russia, the equity market in Moscow closed in February 2022 and did not re-open in a meaningful sense.

With foreigners banned from selling, capital controls imposed and tight financial sanctions on the country, it became impossible for foreign investors to recover money from Russian equities.

The impact of wide economic and trade sanctions mean the fundamental value of Russian equities is highly uncertain.

GDRs and ADRs of Russian stocks have been suspended. MSCI deleted the Russia index from MSCI EM in March with a zero valuation.

Growth countries

Despite rising global interest rates and bond yields, growth surprised to the upside in several traditionally high-beta, current account economies.

Brazil, Indonesia, India and Mexico were among the better-performing major emerging markets in 2022.

MSCI country index returns were +14.2% in Brazil, + 3.6% in Indonesia, -2% in Mexico and
-8% in India (in USD terms).

Brazil and Mexico benefited from strong exports, while central bank currency support allowed domestic demand growth in India and Indonesia.

Meanwhile, higher energy prices, a sharp slowdown in global technology spending and a worse outlook for global growth meant that Korea and Taiwan both underperformed. MSCI country indices returned -29.4% and -29.8% respectively (in USD terms).

China

Despite improving credit and monetary aggregates data, the Chinese economy remained weak in 2022 as policymakers prepared to stimulate.

The key causes of the weakness were the ongoing policy-driven slowdown in the real estate sector and the impact of Covid lockdowns.

In the final quarter of the year - facing street protests and mounting evidence of the negative economic effect of lockdowns - Chinese authorities began a controlled re-opening of the economy.

MSCI China returned -21.9% in USD terms in 2022, but Chinese markets finished the year with a rising index and a sense of optimism

Positive signs in December quarter

The fourth quarter of 2022 was more positive for emerging and global equity markets, despite ongoing growth and inflation pressures in key economies.

October was difficult, but a shift to a more growth-friendly set of policies in China - and a sense that the outlook for US monetary policy is more positive - led to a stronger finish to the year.

In the quarter MSCI EM Index returned +9.7% in USD terms.

China's economy remained weak despite increasingly aggressive credit and monetary stimulus.

But markets focused on the more positive change in policymaker intentions. MSCI China returned +13.5%  in the quarter (USD terms).

The outlook for US monetary policy also improved in the quarter.

Although we saw interest rate hikes by the Federal Reserve, US CPI continued to trend lower in October and November.

In early November the US ten-year bond yield moved below policy interest rates.

This proved supportive for some emerging markets that had previously been held back by capital outflows.

Which countries are well placed

In the December quarter we saw strong MSCI index USD returns in Colombia (+19.7%), South Africa (+18.3%) and Peru (+17.4%).

Previous winners, especially those with high commodity exposure, generally underperformed in the quarter with softer commodity prices through the middle of the period and reallocation of investment flows towards China.

MSCI Brazil returned + 2.4% and MSCI Indonesia -3.6% (both USD terms).

The weaker oil price hit the Arab Gulf markets harder with MSCI Saudi Arabia returning -7.6%. UAE and Qatar also had negative returns.

Author: James Syme, Paul Wimborne, and Ada Chan, co-managers of Pendal's Global Emerging Markets Opportunities Fund

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