May in review: upturn on the US equity markets, uneven performance by Emerging Markets

In particular, most of the Latin American equity markets delivered relatively weak performance, as in the previous months. In India, markets were close to the recent all-time highs and then moved sideways prior to the announcement of the election results, before ultimately dropping sharply lower in response to the somewhat surprising outcome. In China, some signs of market fatigue were recently seen, following the rebound for equities in recent months. Nevertheless, looking ahead to the coming months the prospects for the Emerging Markets do not look too bad. Equity investors may increasingly start looking for new investment opportunities outside of the USA, as there are signs of a moderate slowdown in the US economy in parallel with quite high valuations for US equities, economic recoveries in China and Europe, and a less synchronised monetary policy path going forward.

Will EM equities break out on the upside?

In May, EM equities once again tried to break out of the long-standing downtrend in their performance relative to the developed markets. This did not succeed, however, mainly due to more robust performance by US equities, or to be more precise, price gains for some heavyweights on the US equity markets, in particular the chip manufacturer Nvidia. Aside from this, at the global level May was also marked by a lack of any new impetus for a strong, broad-based upswing for equities. As an additional factor, many market participants preferred to take a wait-and-see stance, in view of the important interest rate decisions and assessments of the Fed in mid-June.

Support from corporate earnings

Future US monetary policy, the US and Chinese economies, and geopolitical conflicts and risks are still dominating the financial markets at present. But corporate earnings and business outlooks are also exerting significant influence on prices, even if they are not making it into the headlines. The earnings trend is still supporting equity prices for the most part, especially in the USA but also in numerous European equity markets.

Will the Fed sound the all-clear?

US central bankers and the US inflation data released at the same time ultimately ended up sending mixed messages, but it appears that the global equity markets were just fine with that: Rate cuts were delayed a bit longer again, with an eye to the strong figures for economic activity and the labour market. On the other hand, inflation rates for both consumers and producers were slightly better than anticipated, i.e. inflation is declining somewhat faster. This would suggest that we won’t be seeing any renewed strong increases in US bond yields and for the US dollar. Fundamentally speaking, that is a positive situation for equities and bonds from the Emerging Markets. It is also possible that this will open up leeway for central banks in many countries to proceed with interest rate cuts, insofar as they needn’t be worried about major currency depreciation versus the US dollar. At least in theory. Whether this is backed up in practice remains to be seen.

More varied than ever...

Generally, once again it must be noted that while EM equities are viewed as a single asset class, they are actually more varied than ever, and consequently generalisations can only provide a rough initial framework.

For example, commodity-exporting economies behave completely different than countries like China and India. And these two heavyweights in the EM universe also exhibit significant differences. While China has been off the radar for many investors in recent years, India continues to enjoy a run of popularity. China’s equity market has gone from cheap to cheaper, whereas India’s equity market is experiencing exactly the opposite, for understandable reasons.

China’s out, India’s in

Democratic processes (India’s recent massive election went off mostly without a hitch), far less arbitrary behaviour by the authorities, and a good (albeit not perfect) level of legal security are all factors that offer significant advantages, and investors are willing to pay corresponding risk premiums for these aspects. Of course, geopolitics also plays a strong role: For quite some time now, China has been targeted by the USA economically and geopolitically, and thus the risks are bigger. India, on the other hand, is being courted as a partner by Washington, but so far has not really committed to anyone, and has thus kept lucrative economic relations alive with (almost) everyone.

One might also note that Saudi Arabia, which was a close ally of the USA for many decades, is increasingly following a similar path. Just a few days ago, the treaty concluded 50 years ago between the Kingdom and the USA which essentially established the petrodollar ended. Saudi Arabia’s leaders did not extend it. Whether this is just a poker game for better conditions or represents a tectonic shift in global power structures (cf. BRICS+) will probably become more clear in the months ahead.

Good conditions for EM equities?

But let’s return to the Emerging Markets as a whole. Insofar as no new unexpected problems arise, the global economic and monetary policy conditions that are materialising appear to be very beneficial for Emerging Market equities (as well as for EM bonds). There are investment opportunities in many different countries, as evidenced by a look at the large discounts in valuations for numerous EM equity markets compared to the developed markets.

Attractive valuations, good growth and profitability

While it’s clear that these will not completely disappear in the foreseeable future, they don’t actually even really need to do so to be able to offer investors opportunities for good earnings. It may just be enough for international investors to start focusing more on the often very good profitability indicators (dividends, ROE, cashflows, etc.) of the companies from these markets. And if corporate earnings also pick up, it is possible that some fresh money will flow into these markets, especially since most Emerging Markets will experience above-average growth for some time to come. A breakout in the coming months from the technical downtrend mentioned above may be a sign that this process has started.