Comment on Q2 2024: Taiwan, India and China driving emerging market outperformance

Q2 2024 was yet another solid quarter for global markets. Emerging markets outperformed developed markets, with the former returning 5.1% compared with the latter’s 2.8%. This was mainly driven by Taiwan, which returned 12.8% as investor interest in the AI/chips theme remained strong. However, most countries performed well, with China offshore names up 7.2% and India up 8.2%. Our two flagship strategies, Global Frontier Markets and Global Emerging Markets Sustainable remained in the top quartile for the year.

AI remained firmly in the driver’s seat in terms of returns for emerging markets, as Taiwan (now 19% of the index) was the largest contributor to absolute returns, up 12.8% in the quarter. The largest name in emerging markets and in our GEMS fund is TSMC, which produces all of the advanced AI chips for Nvidia. TSMC is now up 50% year to date in USD terms, with the main trigger in the quarter being an announcement that the company would be raising prices for its advanced chips and packaging. Remarkably, this announcement was publicly welcomed by Nvidia CEO Jensen Huang, who explained that TSMC's contribution to the industry was “really great” and that “raising prices, I think, is consistent with the value that they deliver. And so I'm very happy to see them succeed”. We think consensus still isn’t fully pricing in the impact of these hikes and expect revenue growth of around 25% next year, compared with the consensus expectation of 21–22%. We therefore still like the name, which we believe looks reasonable at c. 10x EBITDA for next year.

Figure 1. Equity markets and currency returns in USD

Source: Refinitiv, accessed 02.07.24

We often remind clients that the AI story in emerging markets doesn’t just consist of the chip producers like TSMC and Samsung Electronics, and we’ve done a lot of work researching the “picks and shovels” of AI. As Elon Musk mentioned in a recent podcast, it is actually electrical transformers that pose the greatest bottleneck to AI at the moment. This has been a key, and highly profitable, investment theme for us this year. Examples include large transformer exporters such as Korean companies Hyundai Electric and Cheryong Electric, which have returned 238% and 284% respectively in USD year to date.

Meanwhile, China continued to dominate the headlines as it entered a technical bull market, up 20% from its lows earlier this year. As we’ve always said, the biggest stock moves can often happen when sentiment moves from extremely negative to quite negative, and we believe this is what happened in Q2. While exports remain a bright spot, consumer sentiment and economic activity remain weak, partly driven by the real estate sector. The government continues to drip-feed positive policy measures into the economy, which we believe will start to have an effect in H2 2024. The major announcement in Q2 was a plan to enable state owned enterprises to start buying unwanted real estate stock and converting it into affordable housing. The plan has been expanded from USD 41bn to USD 69bn which will help with reducing the high inventory levels in the economy.

From a more technical perspective, although China is up 22% from bottom, it remains 19% below 2023 highs and 50% off 2020 highs, so there is still more to go. This is even clearer when you look at individual companies. Take China’s largest private higher education company, China Education, which has typically traded at a forward P/E of 20–30x. It is now trading at a forward PE of 5x, which looks highly attractive, especially when you consider dividend yield of 9% and solid growth.

India continued going from strength to strength, adding another USD 1 trillion of market cap in record time (Figure 2). The election volatility, caused by Prime Minister Narendra Modi winning considerably fewer seats than the market expected, was quickly shrugged off as domestic investors continued to pile into the stock market. Indeed, looking at H1 2024, foreign inflows were broadly flat, though domestic inflows were USD 28.5bn, larger than the USD 22.3bn for the whole of 2023. Strategists have, perhaps fairly, referred to this as “irrational exuberance” (a phrase coined by former Fed Chairman Alan Greenspan in 1996), which has led to high valuations across the board. The more optimistic way to look at this is that these domestic flows provide structural support to a strong growth story, as they will reduce volatility compared with markets that are reliant on famously fickle international investors. We remain highly selective, not shying away from small caps, where we think one can find excellent value, but making sure we are investing with promoters (owners) with strong governance records and avoiding stocks that look overly pumped up.

Figure 2. India market cap in USD trillion

Source: Refinitiv, accessed 02.07.24

Frontier markets had a relatively good quarter, with many of the top-performing markets in the world year to date falling into this category, including Kenya, Sri Lanka and Kazakhstan, which returned 45%, 22% and 20% respectively in USD. Looking generally at these markets, we can say that they are now back on track and growing strongly after recovering from the Covid years and the subsequent rebalancing. Performance was already strong in 2023 and is still great so far this year, with c. 20% return in USD both in 2023 and H1 2024. However, earnings growth is continuing, so that the P/E ratio is actually down to 7.2x, rather than up, despite the performance. We still see plenty of opportunities, with most markets in an early cycle.

It was another very busy quarter of travel. One of our most interesting trips was to Korea, where we sensed a different atmosphere from previous visits, due to the excitement around the “corporate value-up” programme. We have written about the programme and our trip; as often with these sorts of things, the market tends to overestimate impacts in the short term and underestimate them in the long term. We believe it is the same here, and that the P/B levels of below 1x for Korea compared with 1.5x for Japan and 3.4x for Taiwan mean there is clear upside here. We also had interesting trips to Thailand and the largest solar fair in the world in Shanghai (500,000 visitors), as well as many meetings and conferences in China, London and elsewhere.

On the sustainability side, we published both our 2023 sustainable investment report and our H2 2023 GEMS impact report, and spoke at some large conferences, such as Greenway in Hong Kong and the BIVA Mexico conference in London. Probably the most important news flow was the Chinese stock exchanges’ guidance on corporate sustainability disclosure, which took effect from May 2024, and is partly mandatory. We have 20 ongoing engagements with 13 Chinese companies, and this sort of development really helps our discussions with issuers.

Going forward, we believe emerging markets remain attractive, given an appealing and diversified combination of strong structural growth in countries such as India, tech exposure in Taiwan and Korea, and low valuations and the potential for a continued rebound in China. This is especially true given the backdrop of falling interest rates, which are generally positive for emerging markets, and their currencies in particular. Frontier and small emerging markets remain a stock picker’s paradise, with high-quality companies trading at appealing valuations across the globe.

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