Emerging-market stocks set to erase 2023 gains

Emerging-market stocks gave up their gains for the year as stubborn inflation and bets on a prolonged period of high interest rates undermine growth prospects in the developing world.

The MSCI Emerging Markets Index closed 1.5% lower at 956.25 points on Thursday amid a broad selloff in global assets. The Federal Reserve’s hawkish messaging on Wednesday — reinforced by strong labor market data this morning — raised the stakes for developing nations. Rate decisions from Taiwan to Turkey and South Africa showed many poorer nations can’t afford to start easing anytime soon.

The year is proving to be a roller-coaster for emerging-market equity investors as post-Covid recovery expectations give way to slowing growth and stubborn inflation concerns. At the core of the underperformance is a $600 billion selloff in China driven by its economic slowdown and debt woes. That’s a setback for money managers who had bet at the start of the year the country’s growth would drive equity outperformance over developed nations.

“With the Fed signaling higher for longer, possibly even hiking again, and China’s economic challenges persisting, emerging-market equities are hit with a dual shock at the moment,” said Brendan McKenna, a strategist at Wells Fargo in New York. “These dynamics are placing a lot of downward pressure on equities around the world, but in particular EM equities.”

The latest losses are taking emerging-market stocks toward a sixth successive year of underperformance relative to US equities. Analysts’ earnings estimates for companies in the MSCI gauge have fallen 2% this year, while valuations aren’t cheap: The index trades at 11.8 times the projected earnings of its companies, only slightly below the five-year average of 12.3 times.

Chinese stocks fell both on mainland and Hong Kong exchanges Thursday amid signs foreigners are still pulling money from the country. Both the MSCI China and CSI 300 indexes closed at the lowest level since November. The ongoing stimulus program in the country is weighing on the yuan, while worries that the measures won’t be enough to arrest the economic slide are battering stocks.

“Market sentiment is awful,” said Greg Lesko, a managing director at Deltec Asset Management LLC in New York. “In a normal world, China would be the place to buy given they are the ones trying to stimulate,” but that isn’t happening.

While stock investors are looking for buying opportunities arising from monetary-policy easing, they are also nervous about countries that have less ability to cut rates because of high inflation. They see Asia, eastern Europe, Middle East and Africa as more vulnerable than Latin America, which boasts some of the world’s highest inflation-adjusted policy rates.

Hungarian stocks posted the world’s biggest losses Thursday after the nation’s central-bank governor hinted at more interest-rate cuts — in a country where consumer-price growth still hovers above 16%. Similarly, assets in Poland witnessed a meltdown early this month after a bigger-than-forecast rate reduction.

Emerging equity markets aren’t without a ray of hope, though. Analysts have raised earnings forecasts for the MSCI index’s companies for seven successive days on growing optimism China’s economic slide may be bottoming out. That might make them attractive to investors once Fed rate bets ease and emerging markets are able to pursue rate cuts.

“I think it’s an opportunity to add, though timing may be put off a bit.” Lesko said.