Volatility and Opportunity

Emerging markets fared pretty well in 2024 but there were divergent trends within regions and between markets. Somewhat surprisingly, given its economic challenges, China was one of the best-performing markets.

Changing expectations for U.S. interest rates and a strengthening and weakening U.S. dollar were big influencers on emerging markets as was the ongoing strength in the artificial intelligence (AI) space. At the beginning of 2024, as inflation prints became more favorable, expectations rose that the U.S. Federal Reserve would start to cut rates. When it finally did cut in September, the projected cadence and scope of more cuts was clouded by renewed resilience in inflation and the prospects of increased spending by the incoming Trump administration.

The other big challenge for emerging markets was domestic politics. Prime Minister Modi’s failure to win an overall majority in India’s general elections, the landslide victory of Claudia Sheinbaum’s left-of-center party in Mexico, and a fraught leadership contest in Japan all created volatility in equity markets.

Amid these global developments, however, we would say the fundamentals of emerging markets in many cases remained intact and have supported investment returns in markets including India and Malaysia.

Tempering growth in India

India’s equity market performed well in the first few months of the year until it was hit by volatility in early June when Modi’s political bloc unexpectedly failed to win a majority in the elections. The market quickly stabilized after Modi secured the support of allies to form a coalition government. Investors generally saw the episode as a positive development, illustrating India to be a functioning democracy. The new coalition has also facilitated a shift to a more balanced economic policy with a less singular focus on infrastructure spend and this has been seen as a positive by investors.  

“The risk of tariffs from the new Trump administration is a concern for emerging markets but a strong U.S. economy is good for global risk assets. In addition, markets such as India and Malaysia have internal growth drivers that hold promise for long-term investor returns.”

In recent months there has been a slight easing of economic expansion in India as consumers experienced higher inflation and there has also been a pullback in earnings growth which has caused a small correction in the market. The weakness in earnings has been fairly consistent across the board but the main impact has been in the mid- and small-cap space and in consumer segments. We believe earnings expectations for mid- and small-cap companies were too high while the earnings of consumer-facing companies were weak. India remains an expensive market but fundamentally we still favor areas that are producing good earnings. 

The good and the bad: North Asia

In North Asia, the performances of Taiwan and South Korea in 2024 couldn’t have been more different. Taiwan gained more than 30% while South Korea declined by around 20%. Taiwan's performance was driven by AI from a narrow range of chip stocks and the supply chain around them. While these stocks have done very well, we still like the sector because earnings growth remains and there's visibility in the earnings.

South Korea has been more difficult. Semiconductor stocks haven’t done as well compared with Taiwan. The sector is less focused on AI and more in the memory space which is quite cyclical. There is also a lot of cyclicality across South Korea’s economy, in heavy industries, for example, where demand has softened particularly from China. Through the year, we've managed to find some good opportunities, such as in financials, whereas sectors such as autos have done poorly amid softening global demand. More recently, market sentiment was affected by political uncertainty in the aftermath of President Yoon Suk Yeol’s short-lived imposition of military rule.

Strong performance in spite of the economy: China

2024 was a challenging year for China’s economic growth as the real estate sector and consumer sentiment continued to deteriorate and consumption remained weak. From a market perspective, Chinese equities delivered a good performance relative to peers. Companies listed in China offshore markets, typically in technology, consumer and ecommerce segments, delivered improvements in earnings growth as they contained costs and bolstered margins rather than chasing revenue and market share. In many cases, they were also shrewd managers of capital, buying back shares and increasing dividends.

The performance of the mainland or A-share market, which includes consumer staples, real estate, industrials and manufacturing, lagged offshore equities. Consumer demand was weak and the property market remained in the doldrums. Manufacturing and industrials-related stocks performed slightly better but they were also impacted by a sluggish domestic economy and a softening global outlook. 

In September, we saw a major shift in China’s commitment to rejuvenating economic growth with a package of measures on the supply side designed to ease the monetary environment, encourage transactions in the property market, and improve liquidity in equity markets. And more recently, there are signs that China’s leadership is starting to address the demand side of the equation. At this time, we are waiting to see the policies that will execute on these plans and they may come at the National People’s Congress in March.

In terms of geopolitics, there was a ratcheting up by the Biden administration of tech-related trade curbs and bans against China but more crucial is what lies ahead. U.S. tariffs on Chinese goods at a rate of 60%, as signaled by the new Trump administration, would undoubtedly hurt China’s economy. But it’s also worth keeping in mind that China’s economy is driven fundamentally by domestic growth and exports to the U.S. represent around 3% of GDP.¹

Masking strong fundamentals in Japan and mixed fortunes in ASEAN

In Japan, there was political and macroeconomic turmoil as the government hiked interest rates into positive territory in August taking the market by surprise and triggering a global selloff in equities. In October, the coalition government failed to win a majority in the election and Prime Minister Shigeru Ishiba needed a runoff vote to be confirmed as prime minister. 

These two factors we think dissuaded many international investors from seeking or adding exposure to Japan. That’s been a little bit disappointing because earnings have been resilient and companies are continuing to reform and generate value via buybacks and dividends. Longer term, we believe that Japanese equities are driven by earnings, and successful stock picking will be key. 

Markets in Southeast Asia had an interesting run in 2024. Domestic demand is recovering and advancing after COVID, consumer markets are expanding, tourism is coming back and global trade is increasing. Malaysia’s market performed well. The relatively new government has been implementing reforms and we've been able to find some opportunities, whether it's been in financials or telecoms or energy. In contrast, Indonesia was challenging. It was hurt largely by the U.S. rate policy. Longer term, we are positive but rates need to come down in order for Indonesia’s economy to improve. Vietnam is a penetration story and its equity market is cheap given its economic growth prospects.  

A longer view needed for Latin America

The Latin American equity market was a significant underperformer in 2024. Both Mexico and Brazil were impacted by elevated Fed interest rates, a strong U.S. dollar and by internal politics.

For Mexico, we've been very cautious since the beginning of the year. Sheinbaum won the general election with a reformist mandate and the market reacted negatively to her victory and to the potential impact her plans could have on the private sector. Going forward, there is the further possible headwind in terms of how the new Trump administration will interact with Mexico on the immigration side and on the tariff side. 

Brazil is in a challenging place. It has a lot of long-term strengths—natural resources, strong demographics and an entrepreneurial culture being among them—but the economy is contending with high inflation and there are mounting worries on the fiscal side that the Lula administration will spend more money than projected. This is all impacting the value of the Brazilian real and country’s global financial standing. Taking a longer-term view, the market is very cheap given the strong fundamentals of many Brazilian companies.

Our Outlook

Looking out into 2025, a key narrative for emerging markets could be the scale of the impact of the new Trump administration. Balanced against this are the intrinsic dynamics of emerging markets and the growth that they're generating internally. 
At the start of the new year, we think the playbook will be one of managing volatility. There are a lot of questions over the policies of the new U.S. administration. It could potentially support a higher dollar, potentially higher U.S. Treasury yields and potentially higher interest rates. There are also, of course, concerns over tariffs.

At the same time, the new administration may stoke a stronger U.S. economy and that’s good for global growth and good for risk assets. Emerging markets are growing quite strongly both from their domestic bases and from exporting into the U.S. Most obviously, the AI-related semiconductor industry of Taiwan and South Korea could benefit from continued CapEx spending by large U.S. tech firms.

Beyond the first quarter, if we get more visibility over U.S. trade policies and China’s fiscal spending plans, we may see volatility subside, overall sentiment turn more positive and the earnings performance of emerging markets’ companies becoming more reflected in their share price.

At the macro level, we will probably see Fed rates being cut further. This may not be a clear tailwind for emerging markets but will be less of a headwind, in our view. At this juncture, we would say that a large component of returns from emerging markets in 2025 will be backloaded into the second half of the year.

Further out, over the next three to five years, we believe the outlook for emerging markets is very positive and driven by earnings growth which is coming through in cheap valuations. Multi-year cross-asset forecasts are also generally showing that emerging markets in Asia are positioned to generate improved returns while U.S. equities are projected to deliver a slowdown in returns. 

Sean Taylor
Chief Investment Officer

Source: ¹UN, IMF, Haver Analytics, Morgan Stanley Research