Swiss global wealth and asset manager Lombard Odier discusses the outlook for emerging markets, notably China and Brazil, underlining how investors need to be highly selective in 2023.

Emerging markets have seen divergent economic performance in 2023, amid US dollar strength, oil prices and China’s weak growth, senior macro strategist Homin Lee at Lombard Odier said this week.

“While these economies have never been a homogenous block, 2023 is proving a year in which investors need to be highly selective,” Lee said in a note. His investment positioning focuses on a positive outlook in Brazil, and a more nuanced one on China.

“Divergent stock market returns this year underscore the divergent fortunes of emerging markets. Mexico, which has benefited from the friend-shoring trend in the manufacturing sector, has recorded returns of almost 20 per cent year to date in US dollar terms. Both South Korea and Taiwan’s markets have benefitted from improving outlooks for their technology sectors, thanks to artificial intelligence and electric vehicles,” Lee said.

In US dollars, Brazil’s stock market has been one of the better performers, roughly matching the 13 per cent year-to-date total return of the S&P 500, he continued. The country has positively surprised investors with bumper agricultural harvests that have more than doubled in the first quarter of 2023 compared with the previous three months, improving economic growth, domestic reforms, falling inflation and interest rate cuts.

Higher expectations for Brazil’s 2023 growth and improving fiscal prospects have supported the currency this year. The Brazilian real has resisted the dollar’s recovery against other major currencies, he said.

“In contrast, a slowing Chinese economy has spilled into other Asian economic performance, and the MSCI China index has recorded a 7 per cent loss in dollars by the end of September,” Lee said. "One headwind for many emerging markets has been the comparative resilience of the US economy, which has boosted real returns and thus investor demand for US financial assets over many of their emerging market counterparts."

Many emerging currencies have depreciated against the dollar this year. Higher crude oil prices, which he expects to remain around $90 per barrel for the rest of this year, have also acted as a drag on net oil importers, including many emerging Asian economies. 

Lee is not alone in his views on the slowing Chinese economy. Norman Villamin, group chief strategist at Swiss private bank Union Bancaire PrivĂ©e, believes that China’s struggle with economic recovery remains a headwind for global growth. Villamin maintains a cautious stance for 2024 but expects that incremental stimulus measures in China will continue to be unveiled in the weeks ahead. See more about China’s outlook here and here. 

Winds of change
“In addition, disruptive El Niño weather patterns through 2024 create new risks for emerging markets, where food makes up a significant share of total consumer price inflation,” Lee continued. â€śOne of the key setbacks for emerging economies this year has been China, where historical rebounds in domestic demand have lifted others’ industrial activity. China’s growth has accelerated since 2022, but has underwhelmed markets in 2023.” 

Although there are signs of stabilisation after the weak second quarter, private sector capital expenditure and service sectors continue to slow, partly due to real estate turmoil. Lee expects that piecemeal stimulus and gradual structural reforms will see growth slowing from this year’s 5 per cent to 4.3 per cent in 2024.

Lombard Odier takes a selective approach to emerging market allocations, and consequently remains underweight for the Chinese currency and maintains an overweight position in Brazilian local currency debt in client portfolios and the Brazilian real.Mark Williams, portfolio manager at Somerset Capital Management, also believes that Brazil is a promising market.