Market capitalization-weighted emerging markets (EM) equity indices are extremely concentrated on a country allocation basis. The top 5 nations in MSCI EM (China, India, Taiwan, South Korea and Brazil) currently represent a combined allocation of nearly 80% of the index. Per the chart below, this figure has climbed about 15% over the past decade. This presents an inherent challenge for EM investing, and we are big proponents of (selective) diversification to smaller-weighted nations. That said, it is critical to assess the outlook for the top 5, as their heft means they have an outsized impact on EM equity returns and general sentiment towards the asset class. Despite 4 of the 5 being situated in Asia, the nations have markedly different economic drivers and risk factors; each requiring their own distinct analyses.  

We were emboldened by the surprise removal of Chinese lockdown measures in late-2022 and expected the massive accumulation of household savings to enable a consumer driven-spending boom. Despite an initial surge, the economic data began to fizzle out after the first quarter of 2023. With the benefit of hindsight, we now know that business and consumer confidence suffered immense damage from the combined impact of the property sector turmoil and severe lockdown measures. After a very challenging 2023, Chinese economic data has recently begun to beat expectations. Chinese equities have considerable upside potential from current levels, but repairing depressed investor sentiment will not be a straightforward task.

Early last year, Forstrong’s investment team worried that optimism towards India being a prime beneficiary of supply chain diversification out of China had become overblown, and valuation multiples had reached extremes…even by India’s lofty standards! However, foreign investors continued to pile into Indian equities and propelled the rally further. Looking forward, we have become more constructive on India as a long-awaited credit cycle appears to be developing and the business-friendly incumbent Prime Minister Modi looks set to win another term this year. 

Our view on Taiwan and South Korea last year was influenced by the bottoming semiconductor replacement cycle (chips and broader technology hardware exports have a major influence on Taiwanese and Korean earnings), which despite many investors’ and businesses’ recession fears last year, suggested sales growth should accelerate. However, rapid price appreciation driven by surging artificial intelligence demand expectations caused valuation multiples to rise sharply; decreasing their attractiveness. Nonetheless, we expect Taiwanese and South Korean equities to enjoy continued earnings momentum in 2024, based on the typical duration of past semiconductor cycles and firming global growth. 

Our constructive view on Brazil continues to be multi-faceted. The domestic stock market tends to be quite interest rate-sensitive, and thus the ongoing rate cutting cycle from the Banco Central do Brasil should help reflate depressed valuation multiples. Additionally, we maintain a favourable view towards industrial metal exporting nations such as Brazil. Demand for metals should be well-supported in years to come by electrical grid enhancements and related infrastructure build-outs required to support diversified sources of electricity and EV consumption globally. 

In our recent Ask Forstrong: A Broadening Bull Market? report we noted that world economic activity is re-accelerating and risk appetite is returning to financial markets; emboldening investors to venture further afield. With that constructive backdrop and a generally upbeat outlook for the top 5 nations, we expect EM equities to thrive. However, diversifying outside of these predominant nations helps reduce concentration risk and unlocks numerous compelling opportunities.

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