Emerging market stocks are making a comeback, and investors may find opportunity in North Asian markets, particularly in 2023.
Strategists at Morgan Stanley Research first issued a bullish call on Asian stocks in October, saying earnings growth was likely to moderate, while estimates were 40% below the peak of the February 2021 cycle.
“We believe we are at the beginning of a bull cycle in emerging markets,” said Jonathan Garner, Morgan Stanley’s chief Asia and emerging market strategist. “As in previous cycles, we expect this to be driven by the large North Asian markets of China, Korea and Taiwan.”
Are reasons for optimism at the forefront? “The weakening of the US dollar and China’s move towards more stable COVID management policies have improved the overall revenue outlook for the region,” Garner said.
Additionally, in the Korean and Taiwanese markets, where stocks have largely underperformed in 2022, valuations are cheap and typically before the turn of technology inventory cycles. These early cycle markets have the best track record of leading recoveries in Asian and emerging market stocks.
Emerging markets appear to be coming off one of their longest and most bearish cycles. As of October 2022, the decline in the MSCI Emerging Markets Index has exceeded the average of the previous 10 bear markets, including the 1997 Asian financial crisis. The index fell to 7% below the bottom of the 2018 cycle, and Asian shares were then down more than 40% from their February 2021 peak. Over the past 10 cycles, the stock has reached highs ranging from 22.7% to 124.8%, an average of about 451 days from bear market lows.
Here’s how the EM strategy team thinks the stock rally is likely to play out.
China: The easing of COVID restrictions underpins strategists’ more positive outlook for the economy, which should accelerate to 5% GDP growth in 2023. At the same time, China’s real estate market is stabilizing, and regulatory actions seem to have a large impact on the Internet and e-commerce sectors, he concluded. The team expects earnings growth to increase from low single digits in 2022 to mid-teens in 2023.
Korea: The Korean stock market has historically been a leader in emerging market turnarounds, and it may be again, as it is heavily weighted toward early-stage cyclical stocks. “For quality growth sectors such as technology and capital goods, valuations appear to have declined, and the earnings outlook is likely to improve next year,” Garner said.
Taiwan. The current bearish cycle in semiconductors and technology was fully priced into early October, especially given the trend of improving profitability for companies in these sectors. Downward earnings revisions are likely to be revised by the middle of next year. Other indicators of the rally in Taiwan’s stock market include a full reopening from the COVID-related shutdowns. This can bring in an influx of visitors and provide a further boost to the domestic economy.
India: Given the high valuations and comparative advantage of India’s stock market this year, it may lag the recovery in China, Korea and Taiwan. However, Morgan Stanley’s India strategists are positive about the country’s prospects over the next decade and believe the market will benefit from investor interest and long-term shifts towards a multipolar world.
In recent weeks, Asian markets have become less sensitive to trends in US markets, particularly for Chinese stocks, which is typical of the early stages of a recovery. As an early cycle asset class, Asian stocks tend to peak before the S&P 500 in February 2021 this cycle, and before the S&P 500 as well.
Ongoing risks to the market rally remain, including the impact of global inflation on overall equity valuations, as well as geopolitical factors such as China-Taiwan-US interactions, timing of China’s reopening and ongoing Ukraine-Russia fallout. conflict over energy prices.
However, key indicators point to an attractive risk-reward proposition for investors, positioning emerging market stocks more favorably than developed markets over the next year.
For additional Morgan Stanley Research insights and analysis on Asia and emerging markets, ask your Morgan Stanley representative or financial advisor for the full report, “Asia/EM Equities Upswing; Buy Korea and Taiwan” (Oct. 4, 2022) and “New bull market continues. raise Asia/EM index targets; improve China to overweight (December 4, 2022). Morgan Stanley Research clients can access the report directly here and: here. Plus read more Ideas of Morgan Stanley’s thought leaders.
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