Jonathan Garner: Tracking Asia and EM Outperformance

Emerging markets are turning bullish and China’s reopening leaves room for an increase in consumption. What sectors and industries might benefit from this upturn?

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Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and emerging market equity strategist at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, in this episode I'll explain why the bull market in emerging market equities is still young. It's Thursday, 2nd of February at 8 a.m. in Singapore. 

In our view, the bull market in emerging market equities is still young. We entered a bull market, conventionally defined as up 20% from the trough, in the second week of January, having completed the bear market in mid-October. And bull markets typically last at least a year in our asset class, although the pace of recent market gains will probably slow. 

Unlike the U.S. market, earnings estimates revisions in Asia and emerging markets are now inflecting upwards, and that's why emerging equities are performing U.S. equities more rapidly even than in early 2009. And we think this outperformance is likely to continue a while longer. As we've entered a bull market the 52 week rolling beta, or measure of correlation of emerging markets versus U.S. equities, has undergone a regime shift falling from around 0.8 times in the third quarter last year to just 0.4 times currently. And even more striking, the beta of the Hang Seng index, at the leading edge of the current bull market in our asset class, compared to the S&P 500 has fallen close to zero. This is lower than at any point in the last 30 years of data and speaks to an environment of extreme decoupling and performance. 

These factors have led us to raise our growth stock exposure in recent months. Particularly in North Asia ex-Japan, so that's China, Korea and Taiwan, we expect those markets to continue to outperform, as is typical in the early phases of a bull market, whilst we expect Southeast Asian markets, ASEAN and India, which were defensive outperformers during the bear market to underperform as the bull market gets going. 

On the sector side, we're overweight semiconductors and technology hardware and think that the fourth quarter of 2022 was the trough for industry fundamentals, with recovery expected in the second half of this year as inventory reduces and demand recovers, particularly in China. Whilst we praised our emerging markets and China targets several times in recent months, we recently cut our Japan target for TOPIX given the headwind of yen strength. And we prefer Japan banks to the overall market as they're one of the few sectors that's positively leveraged to a stronger yen. 

Finally, we'd like to emphasize that China reopening is probably going to be more V-shaped than the consensus expects, with substantial excess savings in consumer pockets likely to support consumption through this year. Now, this factor is prima facie more bullish the energy sector, which we're also overweight, than the broad materials sector, which is more leveraged to property demand in China, which we think will be slower to recover. 

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