Morning Note: Market news and a view on Emerging Markets equities.

Market News

US equity markets edged higher last night – S&P 500 (+0.3%); Nasdaq (+0.2%) – while a technical indicator showed stocks are in overbought levels. This morning in Asia, markets were generally firm: Nikkei 225 (+0.9%); Hang Seng (+2.3%); Shanghai Composite (-0.6%). The FTSE 100 is currently trading 0.2% higher at 7,654. The 10-year Treasury yield continued its recent slide to 3.9%. US mortgage rates fell below 7% for first time since August. Gold trades at $2,037 an ounce.

The PBoC injected a record 800bn yuan ($112bn) via one-year policy loans, the most ever, as it seeks to support China’s economy. Today’s data provided more evidence of the country’s economic woes: November industrial production beat expectations, but investment in property development remained a serious drag, plunging 9.4%.

The 10-year Gilt yield fell to 3.75% after the BOE maintained interest rates at a 15-year high, in line with expectations, while upholding a hawkish stance. Policymakers noted the probable necessity for an extended period of restrictive monetary policy to control inflation, while also highlighting the potential for further tightening. Consumer confidence edged higher in December as households looked forward to lower inflation and a slightly improved economy in 2024. GfK’s sentiment measure increased from -24 to -22. Sterling buys $1.277 and €1.161.

The oil price continued its recent recovery – $76.90 a barrel – and is set for its first weekly rise since October. A Russian state-owned uranium company said the Kremlin may pre-emptively stop exports to the US if Washington bans purchases starting in 2028, people familiar said. Tenex’s US unit warned power utilities including Constellation, Duke Energy and Dominion to prepare for such an outcome.

We will resume our Morning Note on Tuesday 2 January 2024 and would like to wish all of our clients and readers a wonderful time over Christmas and the New Year. Thank you for your support during 2023 and we look forward to the coming year.

Source: Bloomberg

Macro View - Emerging, Submerging, and Diverging Markets

MSCI China (Blue) and MSCI India (Orange) Indexed to 100 over Five Years

Source: Bloomberg

Emerging Markets often get lumped together as a single asset class.  However, this increasingly doesn’t do this diverse group justice as there are often very different stories unfolding.  The chart above shows the performance of the stock markets of the two largest components of the Emerging Markets index, China and India.  China currently makes up 24.4% of the MSCI Emerging Markets Index, while India is second at 16.9%.  The chart above shows the 5-year capital performance of these markets with India up 91.5% and China down 27.5%.

Sentiment towards Emerging Markets has been poor for a decade.  The chart below shows the shares outstanding in the most popular Emerging Markets ETF (EEM US) which have more than halved over the period.

iShares MSCI Emerging Markets ETF

Source: Bloomberg

There are many important factors that have been driving this, not least the bull market in the US dollar over the period which tends to hurt Emerging Markets.  However, much of the recent woes have been centred around China.  As China’s relations with the US have become strained and market participants have become more attuned to the importance of geopolitics in investing, especially in the wake of the Russian invasion of Ukraine, outflows have accelerated, and China’s underperformance has continued.  China has become “uninvestable” for many.

Despite the overall outflows from the EM universe, India has thrived.  Clearly, it has benefited from aspects of the “friend-shoring” dynamic as many Western firms have rushed to reduce their dependence on Chinese supply chains.  For fund managers looking for EM exposure ex-China, India is the obvious home.

Nevertheless, most investors with exposure hold a diverse portfolio of Emerging Markets equities and the weakness in the largest component has depressed overall returns.  Judging whether idiosyncratic China risk is something they should be exposed to is a key decision for portfolio managers.  However, sentiment is so bad that the bar for recovery is low.  Anything less than outright decoupling would be a bullish surprise.  From the Chinese side, who are no strangers to getting involved in their domestic financial markets, providing a bid for foreign investors to exit would surely feel unnecessarily generous.  Better to wait until the foreigners are out before stepping in.

China is absolutely a significant risk and there may be trouble ahead.  However firstly, if things really get that bad, their effects will be felt a lot more widely than just the Chinese stock market.  Secondly, if they don’t and/or the Chinese feel the time has come for a bull market, the outperformance could be dramatic with investors underexposed.