The Rising Tide of Emerging Market Equities: A Tech-Fueled Revolution

Emerging market equities faced a significant setback in 2022 as the U.S. economy entered a rate hike cycle, causing a collapse in EM equity markets. However, this downturn presented an opportunity for investors as many emerging market assets were undervalued and ripe for a recovery. The revival began in late 2022, driven by the surge in technology stocks, particularly Taiwan Semiconductor Manufacturing Co (NYSE:TSM) and Samsung Electronics Co (OTC:SSNLF).

In the world of emerging market equities, the performance is deeply interconnected with the cyclical performance of the U.S. economy. These markets heavily rely on exports to the largest consumer market in the world. As the demand for new tech skyrocketed during the COVID-19 pandemic, the iShares Core MSCI Emerging Markets ETF (NYSE:IEMG) experienced a record-high close of $70 in February 2021. Both TSMC and Samsung, among its top holdings, flourished as their domestic shares reached all-time highs.

Unfortunately, the Federal Reserve’s rate hike cycle took a toll on EM equity markets, causing the IEMG ETF to plummet by 41% from its peak in 2021 to a trough of $41.44 in October 2022. The growing trade tensions between the U.S. and China further exacerbated the situation, with popular Chinese-listed stocks like Alibaba Group Holdings (NYSE:BABA) and Tencent Holdings (OTC:TCEHY) experiencing significant declines.

However, a turning point came in October 2022. Emerging markets saw a revival driven by supply chain problems that limited the exports of semiconductors and other Asia-manufactured goods. Additionally, the remarkable growth in artificial intelligence research and development propelled U.S.-listed tech giants like Microsoft Corporation and Nvidia Corporation to new market highs throughout 2023.

Despite facing numerous challenges such as interest rate increases, geopolitical conflicts, and regional banking crises, emerging markets showed resilience. Analysts at Lazard Asset Management remarked that emerging markets remain mispriced and undervalued compared to developed market equities. With valuation discounts of around 30% and 40% relative to developed markets and U.S. equities, respectively, emerging market equities continue to be an attractive alternative for investors.

While China remains a risk factor, the government has committed to supporting its struggling markets. News about these support measures is expected to be outlined at China’s National People’s Congress, its annual political event. However, for investors seeking to mitigate China-related risks, the iShares MSCI Emerging Markets Ex-China ETF (NYSE:EMXC) offers an option by excluding Chinese-listed stocks.

In summary, the downturn of emerging market equities in 2022 provided a unique buying opportunity for investors. The subsequent recovery, fueled by technology stocks and the growth of artificial intelligence, showcased the resilience of emerging markets. With valuations still relatively inexpensive compared to developed markets, emerging market equities have the potential to be a profitable investment for those seeking alternatives to a potentially overvalued U.S. market.

FAQ:

1. What caused the downturn in emerging market equities in 2022?
The U.S. economy entering a rate hike cycle caused a collapse in emerging market equity markets.

2. What presented an opportunity for investors during the downturn?
Many emerging market assets were undervalued and ripe for a recovery.

3. Which technology stocks drove the revival of emerging market equities?
Taiwan Semiconductor Manufacturing Co (NYSE:TSM) and Samsung Electronics Co (OTC:SSNLF) were the key drivers of the revival.

4. What is the connection between the performance of emerging market equities and the U.S. economy?
The performance of emerging market equities is deeply interconnected with the cyclical performance of the U.S. economy as these markets heavily rely on exports to the largest consumer market in the world.

5. What caused the iShares Core MSCI Emerging Markets ETF (NYSE:IEMG) to reach a record-high close in February 2021?
The demand for new tech skyrocketed during the COVID-19 pandemic, leading to a surge in the ETF’s value.

6. What factors contributed to the decline in EM equity markets?
The Federal Reserve’s rate hike cycle and growing trade tensions between the U.S. and China were key factors.

7. What led to the revival of emerging markets in October 2022?
Supply chain problems that limited exports of semiconductors and other Asia-manufactured goods, along with the growth in artificial intelligence research and development, drove the revival.

8. How do emerging market equities compare to developed market equities in terms of valuation?
Emerging market equities have valuation discounts of around 30% and 40% relative to developed markets and U.S. equities, respectively.

9. What option is available for investors seeking to mitigate China-related risks?
The iShares MSCI Emerging Markets Ex-China ETF (NYSE:EMXC) excludes Chinese-listed stocks.

10. Should investors consider emerging market equities as a profitable investment?
Yes, with valuations still relatively inexpensive compared to developed markets, emerging market equities have the potential to be a profitable investment for those seeking alternatives to a potentially overvalued U.S. market.

Definitions:
– Emerging market equities: Stocks of companies located in developing countries with growing economies.
– Rate hike cycle: A series of increases in interest rates by a central bank to control inflation or stabilize the economy.
– Undervalued: When the price of an asset is perceived to be lower than its intrinsic value.
– Revival: A period of recovery or renewed growth after a decline.
– Semiconductor: A material with electrical conductivity intermediate between a conductor and an insulator, often used in electronic devices.
– Geopolitical conflicts: Conflicts between countries or regions relating to political and territorial disputes.
– Banking crises: Instances of significant problems in the banking sector of a country, such as liquidity or solvency issues.
– Valuation discounts: Differences in the value of an asset compared to similar assets in terms of price or worth.