Will emerging markets stage a comeback in 2024?

China is the big unknown in 2024

For many global investors China has increasingly become uninvestable due to trade frictions between the US and China, the war in Ukraine, increased regulations, capital controls, declining population, and lately an obvious broken economic model. As the figure above shows, Chinese equities have delivered -31% cumulative return in USD terms since 1 January 2018 compared to 66% for global equities and 92% for US equities over the same period.

After the strict lockdowns in China were lifted in late 2022 the market was betting hard on China to deliver a strong rebound in 2023, but the recurring troubles in the real estate sector derailed your dreams. Instead China from weakness to more weakness ending this year with communicated intentions by the government to stimulate the economy even more. While those intentions are good the question is how you stimulate an economy with a lot of slack when it is export driven and losing market share to other countries. Stimulus cannot be directed to real estate because this is an unproductive use of capital at this point. There are no easy solutions for China in 2024.

Return expectations are not kind to emerging markets

Emerging markets have been a disappointment for over a decade now and with strong US equity market returns global investors have increasingly ignored the emerging market story betting on the US technology sector. The main question for 2024 is whether emerging markets can finally get back on track. There are two ways to look at this.

1. In the very short-term EM equity market outperformance is directly linked to the rebound case in Chinese equities. If it does not arrive, then EM equities will underperform again.
2. In the longer run (10 years), EM equities do not look as attractive as DM equities because of capital consumption and low transmission of GDP growth to earnings growth.

Let us look at Indian equities, EM and DM equities and their 10-year real return expectations in USD. As the figure below shows, the dividend yield is very low in India and much higher in EM. The dividend yield is the starting point for setting long-term return expectations in equities. Companies can return capital through dividends but also buybacks. If we look at Indian and EM equities then we observe that since early 2015 companies have consumed capital (issued more common stock capital than decreased common stock through buybacks), which is not necessarily bad if that issued equity capital is used for enabling higher growth rates. In DM equities excess return on capital has on average delivered 1.5% annualised buyback yield.

Finally, and this is the important point, Indian equities are not expected to deliver a significant real earnings growth in USD as Indian publicly listed companies have only grown earnings in USD by around 4.7% per year. If we subtract the 10-year inflation rate expectation in the US of 2.4% annualised then the real earnings growth in USD is only 2.3% annualised. How can it be so low when annual real GDP growth has been around 6.9%. There are several factors behind this such as 1) the Indian Rupee declines on average around 3.5% annualised due to the inflation differential between INR and USD and 2) low transmission between GDP growth and earnings growth. It

Earnings growth in EM in USD terms has been even more disappointing because of Chinese earnings. The real earnings growth in USD has been close to zero since early 2015. There are several factors behind this such as weak commodity markets, stronger USD, weak Chinese corporate sector earnings, and structural growth difficulties. Given we expect the USD to weaken over the next 10 years and commodities will continue to rise we expect real earnings growth in USD can be higher than what it has been over the past 8 years and thus we set expectations below DM at 1.6% annualised.