Discovering emerging markets - Part I

The East

Emerging markets and developing economies together account for 40% of global GDP (current prices). In particular, Asia-Pacific alone produces about 35% of the world's gross domestic product, as well as being the fastest growing economic region (real GDP growth in 2023 of 4.4%, compared to 1.5% in advanced economies and 3% globally). To get an idea, 3 of the world's top 10 countries by nominal GDP are emerging Asian economies (China, India and South Korea). India is already now a bigger economy than France or Italy, but its GDP is expected to grow by 6.3% in 2024 compared to Italy's 0.7% and France's 1.3%.
If, on the other hand, we look at the ranking of states by GDP at purchasing power parity, which takes into account the cost of living and inflation, China comes out as the first global economy, and India as the third, with a real GDP higher even than that of Germany and the United Kingdom, and even behind Indonesia.

In other words, emerging economies are more relevant than we are led to believe.
They represent an investment opportunity that should at least be considered, and we have certainly been doing so for some time. However, hot wars in Europe and the Middle East, tensions in Asia, domestic political problems in Latin America, and a congested electoral calendar are currently a source of great uncertainty, making it more difficult to steer in the markets.

So far, the main headache for investors approaching emerging markets is Xi Jinping's China. After a disastrous month of January, where Hong Kong's Hang Seng index reached 1997 levels (when, to be clear, Alibaba and Tencent had not yet been founded), the month of February saw a decent rebound in prices. However, valuations continue to be relatively low (p/e below the historical average by about 15%), poorly concealing a certain mistrust on the part of the market. The weak economic recovery, which is hampering revenue and profit growth in the short term, could be having an impact. However, the impression remains that the Chinese economy still has room for growth, with Beijing willing (perhaps obliged) to provide more fiscal support. In the meantime, companies are more inclined to return cash to investors through dividends and share buybacks as investment opportunities diminish.

Geopolitical tensions with the USA and Taiwan also had a significant impact. With regard to the latter, despite external pressure from China, which defined the elections as a matter of choosing between 'war and peace', the presidential elections in January sanctioned the victory of the independence party led by Lai Ching-te. Certainly, the high strategic importance of the island, world leader in chip production thanks to the companies TSMC and UMC, makes the situation even more delicate. Also around the corner is a new escalation of the trade battle with the States, given the possible affirmation (or at least not excluded by the polls) of Donald Trump in the race for the White House.

All this discourages investors, makes them hesitant. Even if remote at the moment, a possible Sino-American conflict on the Taiwan front would freeze the Chinese markets, as, for example, happened in Russia.

To dampen the mood a little, however, it must be acknowledged that these tensions have been going on for quite some time now, and this has not prevented the Chinese market from thriving over the past 15 years (Hong Kong's Hang Seng hit its highs in January 2018, at the height of the Trump administration).

So there is more behind the negative momentum of the Chinese market and in our opinion, what is really limiting foreign capital flows to China is Xi Jinping's autocratic drift. Jack Ma's story is a vivid memory in the minds of all investors interested in the Asian market. Founder of Alibaba and Alipay, Jack Ma had been able to supplant Amazon in the Dragon, becoming the richest and most famous man in China, and going so far as to afford the luxury of taking positions critical of the government. The Communist Party acted accordingly (as per tradition). The result? The billionaire disappeared for several months and underwent considerable downsizing, forced to relinquish control of Ant Group, the company that manages Alipay, and to sharply reduce his public outings. In essence, Xi Jinping has sent a clear and unequivocal signal: no one can afford to challenge the Communist Party and share its power, not even the country's richest and most influential entrepreneur. This, inevitably, puts a brake on foreign investors, who are worried about a central government that can intervene as and when it wants in a way that is completely impossible to predict.

It is no coincidence then that we have witnessed the overwhelming rise of an eternal unfinished country in the vast Asian landscape: India.

The country is experiencing a strong increase in private consumption, leading to GDP growth estimates for 2024 unparalleled in the world at 6.5%. In addition, the expansion of the middle class and the reform cycle initiated by Prime Minister Narendra Modi, whose re-election in 2024 seems more than likely, provide a decent margin for future growth.

Against this backdrop, a stock market at all-time highs is not surprising, with the Indian Sensex index up almost 25% from a year ago, helped by a relatively weak Indian rupee and the redirection of foreign financial flows to China.

However, this is reflected in very high valuations, with a price-to-earnings ratio of about 11% above the historical average. In fact, comparing the p/e of the stocks with the largest market capitalisation against the relative historical average, one can see that Reliance (an oil company) is overvalued by more than 50%, Tata and Larsen&Toubro by around 50%, and Infosys by almost 40%. These data suggest maintaining a wait-and-see position, ready to seize any opportunities in the event of a downward correction that renormalises prices.

Considering the importance of the semiconductor industry, already mentioned earlier with regard to Taiwan, South Korea, the third largest exporter of microchips globally, should also be mentioned. The South Korean economy has a number of themes that suggest considerable structural growth potential. It boasts three companies, Samsung, LG and SK Hynix, which are major players in the increasingly important semiconductor and battery sectors. There is, however, one very important aspect to consider. Taking a look at the sector composition of the MSCI South Korea index, it can be seen that cyclical sectors (IT, consumer discretionary, industrials, materials, communication and energy) weigh more than 90% on the index. This implies greater fluctuation and less predictability of earnings, and, by extension, prices (the IShares ETF based on the MSCI South Korea index has a standard deviation of 27%, not low then).

Summing up, the Asian landscape is varied and interesting. It cannot, therefore, be overlooked in investment choices, and it is certainly not our intention to do so. In prospective terms, after taking profits on the Indian equity component, we have returned to look with great interest at Chinese equities, whose valuations, as mentioned, are too low even in objective terms to disregard.