Matthews Asia - CIO Investment Outlook - My Road Map for 2024

The outlook for emerging markets, I think, is better than it has been for the last 10 years. U.S. interest rates are looking downward not upward, many key emerging markets are in strong fiscal health, and earnings growth in the U.S. is projected to slow, potentially raising the appeal of other investment destinations.

Taking interest rates first, inflationary pressures have receded, in our view, and it’s now a question of how long the Federal Reserve holds out before embarking on rate cuts. And a downcycle in U.S. rates is good for emerging markets everywhere provided it’s not too rapid. In Brazil, real interest rates are around 8%* and rates could come down dramatically there. Falling U.S. rates also tend to put downward pressure on the U.S. dollar which is very positive as it encourages capital flows to overseas markets including Asia.  

In terms of the financial condition of emerging markets, it’s fair to say many have dealt with the COVID crisis much better than they have previous crises. They were much more attuned to the need to increase interest rates and were a lot more coordinated with the Fed. And they didn’t use money to fiscally support consumers like developed economies did. Their finances are in generally good shape and earnings growth in many areas are on good trajectories.

“The real opportunities, we believe, certainly for this coming year, are domestic structural growth drivers in emerging markets. Importantly, these could offset any slowdown in global trade and economic activity.”

While I’m bullish on the outlook for emerging markets I recognize that the last 10 years have been challenging in large part because the U.S. has done so well, largely because of its superior earnings growth. A lot of this has been due to innovation and increasingly the performance of a handful of tech giants, the so-called ‘Magnificent Seven’. I'm not saying that the U.S. won't deliver positive returns for investors over the next couple of years but it’s going to get a lot harder, in my view. 

The regional view

As I gauge how 2024 may unfold, I’d like to take a closer look at the regional level. In Latin America, aside from interest rate cuts, another driver I see is infrastructure spend. Economic growth across Latin American markets may be choppy but governments there are increasingly focused on equal distribution of income. Consumer markets are also getting bigger and governance is improving. Of course, Latin America is strong in commodities and if we see a slowdown in the U.S. and globally, the economies of Brazil and Chile particularly may be challenged.

The Middle East and Eastern Europe are both in very difficult situations because of tragic military conflicts. With regard to both Ukraine and Israel-Gaza it is to be hoped progress is made toward solutions sooner rather than later and the nature of these outcomes will be incredibly important.

The wider Middle East landscape has been changing as certain economies, notably Saudi Arabia, look beyond oil. Saudi Arabia has gone from being a very old-fashioned economy to one that is trying to embrace all aspects of capitalism, from infrastructure spending to manufacturing to mass consumerism.

If we turn to Asia, in recent years it hasn’t particularly helped itself. Earnings have been tepid on the whole, particularly in China. But we believe these economies are finding their feet post COVID and we expect some cyclical growth to return. However, the real opportunities, we believe, certainly for this coming year and the near term, are the domestic structural growth drivers. Importantly, these could offset any slowdown in global trade and economic activity.

Structural growth 

Nowhere in the emerging markets is there a better example of infrastructure-related growth than India. It’s been a market that perennially seems to offer the best opportunity in Asia but I think the real change in India is now the willingness of the government to reform. You can see the infrastructure being built and it is coming through in earnings. Another tailwind has been the surge in domestic equity inflows. As more household finances are shifting to investments away from savings there has been increasing infiltration and support from superannuation systems. People are beginning to discover the structural story of India. You’re starting to see a widening out of the economy. This all said, in 2024 we will stay mindful of valuations in India. We are selective in our exposures but we remain positive on this market.

I also believe the structural story in Indonesia is extremely good. I think, however, the challenges are a bit greater than they are in India. There has been a lot of investment in the commodities side and if we get a global slowdown in tandem with China still underperforming then maybe expectations are a little high in the near term. Other markets like Thailand, Malaysia and the Philippines are still struggling to pick up post-COVID. They have been particularly hurt by the weak recovery in China which they rely on for trade and tourism. So I’m a little cautious on them for 2024. Elsewhere, Vietnam is also an infrastructure story and will continue to yield opportunities, in my view, as it establishes itself as a low-cost manufacturing hub.

Japan in many ways has been the market that has surpassed all expectations in 2023 and we think the narrative is just unfolding. It has been through major structural reforms over the past decade or so and we are now seeing the fruits of this. The implementation of capital reforms this year looks like a game changer. Returns on equity (ROE) are improving, dividend yields are up and stock buybacks are increasing. Companies are focusing on getting rid of non-core activities, focusing more on costs, using their balance sheets better and improving governance.  

The next part of Japan is about macro shifts. The yen has been incredibly weak and interest rate policy has been incredibly accommodative. This is now starting to reverse as inflationary growth is taking hold and this transition is going to have a significant impact on the earnings of domestic companies like financials and real estate, as well as consumer markets. I think as we progress through 2024, the Japanese opportunity will become much more well-known and will have broadened out as well. I think you'll begin to see local investors, either through pension funds, insurance companies or directly themselves, starting to add to the market, and overseas investors also shifting money to Japan from the U.S. 

Patiently positioned

Which leaves us with China, the elephant in the room. It is the one key market where we haven’t seen a robust recovery from COVID and in that regard China potentially offers complete diversification from the rest of the world.

I tend to break China down into three simple blocks for growth: manufacturing, property and domestic consumption. In the coming year, Chinese manufacturing growth will be shaped by global demand, I believe, and the degree to which there is a slowdown. This growth driver will likely also continue to be affected by ‘China Plus One’ strategies, where global companies move operations from China to other locations such as Vietnam and India in order to skirt or avoid geopolitical volatility or regulatory interventions by the Chinese government.

On the property side, the Chinese government needs to take more measures to stabilize the sector and shore up confidence. I don’t see a big fiscal bazooka coming and I would question its impact given the size of China’s economy. China also needs the private sector to continue to make advancements in technology and innovation and to create more employment. Government policy to shore up the property market and encourage the private sector will help the third driver: domestic consumption. As we move through the year, I see the economy picking up a little but I think in 2024 we will have to stay patiently positioned on China.  

2024 is also a year of elections across our markets, in countries including Indonesia, Taiwan, India and South Africa, and these will be key for domestic policy. The U.S. election will also be important in terms of political relationships with China and the rest of the world. It could also be significant for monetary policy and whether interest rates come down quicker because it's an election year. And geopolitics will stay in the conversation but, in my view, it has always been part of investing in emerging markets. It is baked into our models.

My watch word for investing in emerging markets in 2024 is patience. We saw some positive developments in 2023 but we continue to see challenges. Here at Matthews we will be positioned to leverage the potential structural-growth opportunities that our markets have to offer while being mindful that the journey to sustainable returns for our investors will be a marathon not a sprint.

*Bloomberg

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