Podcast - Conditions ripe for EM outperformance in 2024

13 February 2024

The content below is an extract from an Investment Executive original piece published on 30 January 2024. Northcape Capital is the underlying investment manager for the Warakirri Global Emerging Markets Fund.

Conditions ripe for EM outperformance in 2024

There are “bargain basement valuations” to be found in emerging market equities, thanks to an overvalued U.S. dollar and a year of geopolitical uncertainty, says Ross Cameron, portfolio manager with Northcape Capital.

Cameron said asset allocators cannot afford to ignore current valuations.

“The last time emerging market equities were this cheap [and] trading on the multiples that we see in the market today was late 2003,” he said. “And that was just before the EM asset class rallied 230%.”

He said the clear catalyst for extended performance by EM equities is the overvalued U.S. dollar.

“On every metric that we could think of, the U.S. dollar looks very overvalued. On purchasing power parity [and] interest rate parity, if you look at the DXY index versus the long-term trend, the U.S. dollar is overdue an extended period of decline,” he said.

“History tells us that every single time we’ve seen a sustained period of U.S. dollar decline, it’s coincided with strong outperformance for emerging markets,” he said. “So, the environment and the valuation are both indicating that emerging markets are overdue an extended period of outperformance.”

Given that backdrop, Cameron said, it is no surprise that emerging market equities performed quite well last year — if you ignore China’s weak performance.

“The EM index finished the year up 7% in Canadian dollars in 2023, which doesn’t sound too bad. But the EM index ex-China was up 17% in Canadian dollars. So that headline number includes a very weak performance from China,” he said.

Leaving China aside, he said, many emerging economies continue to be well positioned for 2024.

“We have a situation where emerging-market central banks have been very proactive in raising rates ahead of their developed market peers. And they’ve got inflation well and truly under control,” he said. “As a consequence, they’re starting to actually cut rates. We’re not going to see any further hikes in the major emerging markets. And that’s going to underpin strong share price performance, as those discount rates come down.”

In the constellation of emerging market players, he’s particularly excited about three stars: Mexico, Brazil and India, which were up 32%, 29%, and 17% respectively in Canadian-dollar terms in 2023.

“Mexico is one of the clearest beneficiaries from the decline in U.S.-China relations, [and the rise of] this concept of nearshoring,” Cameron said. “I went to Monterrey, which is somewhat the centre of this nearshoring/onshoring effort. And it’s booming.”

For its part, Brazil represents the recent resurgence in Latin American markets, marked by high-quality companies and high-quality management.

And India has explosive potential, with excellent demographics and forward-thinking leadership, he said.

“On the other side of the ledger, it’s really just the one [laggard]. It’s China, which declined 15% in Canadian-dollar terms,” he said. “And that has a disproportionate impact on the index, given that it’s around 30% of the EM index.”

As for companies he likes, he said Taiwan Semiconductor Manufacturing Co. Ltd. and South Korea-based Samsung Electronics Co. Ltd. are superbly positioned as manufacturers of the world’s best semiconductor chips for logic applications.

“The number of applications for logic chips has grown tremendously. AI is just the latest application,” he said. “That’s one of the reasons TSMC is guiding for 20%-plus revenue growth this year.

The other area of technology he likes is the direct random-access memory (D-RAM) sector, which makes the memory used in laptops, smartphones and a growing list of everyday devices.

“Two of the three [market leaders] are emerging market companies. Samsung Electronics and [South Korea-based] SK hynix Inc.,” he said. “And [the D-RAM sector] is subject to the same structural tailwinds of artificial intelligence, Internet of Things, and the continuing growth in computing power. It’s one of the most attractive spaces globally.”

Cameron said the emerging-market theme of 2024 is, without doubt, elections.

“A staggering portion of the global population will go to the polls this year,” he said. Among the countries electing senior executives are Taiwan, India, South Korea and Mexico.

“The challenge for fund managers,” he said, “is to do your homework, understand the various candidates, and position the portfolio accordingly. Because politics absolutely matters in emerging markets.”

Northcape Capital

Northcape Capital
Expert Investment Partner