Companies in emerging markets (EM) are at record cheap valuations, their lowest versus developed markets since 20021. While this may be sufficient to convince some investors of the buying opportunity, Chris Tennant, co-manager of Fidelity Emerging Markets Ltd, believes these facts don’t paint the full picture. Here, he outlines five key themes that he believes make EM equities a compelling asset class right now.

Positive outlook for returns and attractive valuations

Fidelity’s estimates for next year indicate that the emerging market index could see better net income growth, sales growth, and return on invested capital than the global index, as well as lower levels of debt2.

Given that current valuations are at trough levels and seemingly out of sync with the improved fundamental environment, we think this offers an attractive entry point for the emerging market equity asset class.

Geopolitical tensions have also depressed the valuations of many high-quality emerging markets companies. A comparison of Nvidia, the US chipmaker, and TSMC, Taiwan’s pureplay chip foundry is one example, whereby the former share price has arguably been accelerated by AI hype, whilst the latter has been broadly flat, largely due to the market’s perception of geopolitical risk, rather than any fundamental issues with TSMC’s business.

Solid fiscal positions and inflationary control

The fiscal positions of EM countries have strengthened since 2013, with better current account balances, less dollar-denominated debt, and more significant foreign exchange reserves.

Borrowing among EM economies has largely shifted from dollar-denominated debt to local currency, reducing the vulnerability of emerging markets to dollar strength and higher US interest rates.

There has also been more discipline from emerging market central banks this cycle, which have been ahead of the curve in raising rates. With inflation under control, rates should start to come down this year, acting as a tailwind for the emerging consumer.

Within our portfolio, we are increasingly positive on Latin America, where a proactive approach to raising interest rates has brought inflation under control.

Strong performers in the region include digital challenger bank Nu Holdings, which has managed to buck the trend of deteriorating credit quality in Brazil, demonstrating strong asset quality, consistent cost control and a strong brand profile.

Asia growth and Chinese consumer spending

The IMF forecasts that Asia will generate 70% of global growth this year3 . Consumption will be key, as a recovering Chinese consumer offsets weaker demand elsewhere. The $1.5-1.7trn of excess savings accumulated by Chinese households during prolonged lockdowns will help to bolster spending, however, the rebound in consumer confidence and economic growth will not be linear.

We are likely to see a K-shaped recovery given the distribution of excess savings in China is unevenly spread. There will likely be a heightened focus on quality characteristics such as brand proposition and competitive advantage, as consumers demand better value for money in a more challenging macroeconomic environment.

We have played into this theme by adding Midea, the world’s largest home appliance company. China’s domestic air conditioning sales are expected to benefit from recovering consumption and Midea’s execution has been strong, with its B2B segment well on track to deliver both top line growth and margin expansion.

Deglobalisation and nearshoring

Rising geopolitical tensions and disrupted supply chains mean companies are increasingly looking to move their supply chains closer to home. Tesla moving its factories to Mexico is one well-known example.

This could boost not only those industries directly impacted, such as industrials, logistics, materials, and railroad companies, but also consumer and financial businesses as shifting supply chains prompt migration and growing demand for goods and services in these countries.

As such, we have added positions in Mexican railroad operator Grupo Mexico Transportes and GCC, a Mexican cement business, which both stand to benefit from the positive driver of nearshoring.

Higher commodity prices as a tailwind

Commodity prices are a key driver for economies such as South Africa, Mexico, and Brazil, supporting their exports, foreign exchange reserves, and current account balances.

We have a positive outlook for commodity prices over the longer term, with decarbonisation set to drive prices higher as increased demand for energy and raw materials is coupled with a lack of political will to invest in new mines and energy sources.

This comes on top of ten years of underinvestment in the commodity complex, with the move to decarbonise the global economy only set to bolster demand given the commodity dependence of green technologies.

We retain strong conviction in copper, despite weakness in its price during Q2 2023 due to concerns over softening demand from China.

1Bloomberg, 26 June 2023
2Fidelity International, July 2023. Fidelity analyst estimates.
3IMF, World Economic Outlook, April 2023. ‘Asia poised to drive global growth, boosted by China’s reopening’, 1 May 2023. Note: Groupings based on IMF Regional Economic Outlook classifications

Important information

The value of investments can go down as well as up and investors may not get back the amount invested. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. The use of financial derivative instruments for investment purposes, may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Investors should note that the views expressed may no longer be current and may have already been acted upon. The shares in investment trusts are listed on the London Stock Exchange and their price is affected by supply and demand. Investment trusts can gain additional exposure to the market, known as gearing, potentially increasing volatility. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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Nick Price

Nick Price

Portfolio Manager, Fidelity Emerging Markets Fund & Fidelity Emerging Markets Limited