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Reading: Emerging markets equities lag behind developed markets in Q2 2023
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Dailynewsegypt > Blog > Business > Emerging markets equities lag behind developed markets in Q2 2023
Business

Emerging markets equities lag behind developed markets in Q2 2023

Shaimaa Raafat
Last updated: 2023/08/16 at 12:13 PM
By Shaimaa Raafat 8 Min Read
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Emerging markets equities lag behind developed markets in Q2 2023
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Better-than-expected economic data and a stable banking system have quelled concerns of a “hard landing” or financial crisis in the United States, according to Mashreq Capital’s Q2 2023 Market and Strategy Report.

The report said the stronger economic data has led to higher US Treasury yields in the second quarter of 2023. In developed market fixed income, the higher US Treasury yield was counterbalanced by spread compression of corporate credits as recession fears receded.

High-yield bonds outperformed investment-grade, and sovereign bond yields increased in other major developed economies, mainly driven by inflation readings higher than expected, especially in the UK and Australia.

Emerging market fixed income also performed well against higher Treasury rates in the second quarter, delivering positive returns as spreads over Treasury bonds narrowed. High-yield bonds also outperformed investment grade in this sphere, bolstered by positive developments in weaker-rated sovereigns like Egypt, Nigeria, and Turkey.

JP Morgan’s Emerging Market sovereign and corporate bond index saw gains of 4.09% and 3.64% respectively during the quarter.

GCC bonds lagged behind the broader emerging market (EM) space in the second quarter of 2023, as investors shifted their attention to select distressed EM sectors that were demonstrating a solid recovery, said Amol Shitole, Head of Fixed Income at Mashreq Capital. 

The JPMorgan GCC Index still posted a positive return of 0.41% for the quarter and 2.18% year-to-date, however, buoyed by robust fiscal health and a decrease in financing needs within the region.

Heightened investor appetite for credit risk led to superior performance in regions like North Africa and Turkey, bolstered by a series of favourable developments.

Looking ahead, Shitole, acknowledged the persisting volatility in US Treasury yields due to tight labour market conditions in the US.

“Even so, with growth expected to decelerate towards the end of the year, we could see a rally in US dollar bonds as we move into Q4 2023,” Shitole said.

The report also reflected on EM US dollar bond spreads, considering them tight by historical standards, indicating that any positive return would likely arise from compression in US Treasury yields.

Ibrahim Masood, Director, Head of Equities, at Mashreq Capital, explained, “Globally, growth is anticipated to continue its slowdown, as major developed economies struggle with inflation that keeps interest rates high. Additionally, China’s economic recovery, slower than expected, is likely to keep EM growth in check.”

He added that a divergence in monetary policies of developed and emerging markets is expected to become more pronounced as the US is poised to tighten further while some EM central banks lean towards cuts, likely to accelerate once the US pauses.

The sentiment remains negative as rising US treasury yields unsettle investors. 

However, a rapid reversal is anticipated as US economic data is expected to display signs of softness in response to higher rates. Despite relatively tighter EM spreads, Mashreq Capital considers overall valuations as attractive due to higher absolute yields. 

While returns in the first half of 2023 were primarily driven by spread compression, returns in the second half are expected to be contributed by US Treasury yield compression.

The equity markets remained highly focused on central bank policy actions. Developed markets, especially the US, continued to outpace Emerging Markets significantly. The S&P500 Index returned 8.74%, the Nasdaq 100 Index returned a robust 15.39%, and the Euro Stoxx 50 Index posted a return of 4.25%, while the MSCI Emerging Markets Index posted a modest total return of 0.97%. The SPACPUX Index posted a total return of 3.92% for the quarter.

Developed markets showed strength during the quarter, with the Nasdaq 100 Index posting one of the highest total returns for the first six months of the year, up 39.35% on a total return basis. The Euro Stoxx 50 Index was up 19.18%, with the S&P500 Index close behind with a 16.88% return. These numbers pushed valuations for developed markets well above historical averages, moderating prospects for medium-term returns over the next 3-5 years.

Emerging Markets (EM) equities lagged developed markets significantly 

In contrast, Emerging Markets (EM) equities lagged developed markets significantly. For the first six months of the year, EM equities were up just 5.02%. EM equities’ valuation, as measured by the MSCI Emerging Markets Index, was about a quarter standard deviation below the historical average, making this asset class appear slightly cheap.

In the MENA region, equities managed a turnaround in the second quarter, rising 3.92% to finish the first half of the year up 2.42%. Saudi Arabia led the way, rising 9.13% in the quarter, while Dubai rose 12.49%, significantly due to Gulf Navigation’s performance. However, Qatar fell by 1.04%, and Abu Dhabi rose by just 0.94%.

“In this context, the Fed added another 25 basis points in rate hikes and paused during the June meeting before adding another 25 basis point hike in July. The key question now is about the timing of rate cuts, which would be bullish for fixed income but neutral or bearish for equities, or a stepping stone to more hikes, which would be neutral or bearish for fixed income but neutral or bullish for equities. Core inflation remains at 4.6%, while unemployment is at decade lows. The direction of inflation and unemployment will likely inform the Fed’s future actions,” commented Ibrahim Masood Director, Head of Equities.

Developed market equities have remained firm as US economic activity has shown resilience. Inflation remains high in most developed market economies, with only the US running a positive real rate based on core inflation. If other developed markets begin to cool in line with the US, without shifting to positive or at least zero real rates, it will be interesting to see how this impacts equity market performance.

Emerging market equities are slightly cheap compared to history but are unlikely to stand firm if developed market equities begin to weaken. Therefore, a generally conservative stance is advisable for investors with a medium to long-term horizon.

MENA equities have been impacted by aggressive production cuts by OPEC+, led by Saudi Arabia. Concerns about global economic growth have kept oil prices in check, with any gains proving transitory. Nevertheless, the story of energy capacity addition in Saudi Arabia, Qatar, and Abu Dhabi continues to play out. Given that MENA is a dollar bull region, it should continue to outperform the broader Emerging Markets. Recent surveys show that active fund managers remain underweight in the core EM markets in the region (Saudi Arabia, Kuwait, Qatar, UAE), which is seen as a structural medium-term tailwind for the region. Therefore, there continues to be a preference for bottom-up domestic demand and infrastructure plays in the favoured markets.

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Egypt's Emigration Minister meets with founding board of Egyptians Abroad for Investment Company
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