2023 outlook for emerging-market equities

Emerging (EM) equities are entering 2023 at a somewhat depressed level, leaving them with some rebound potential if and when the macro environment improves. They are indeed more advanced in the earnings compression cycle than developed-market (DM) equities and valuations remain lower. We have set our year-end 2023 target for the MSCI EM Index at 1,000, based on a 12-month forward price-to-earnings ratio of 12x and flat earnings per share. 

Overall, we believe a number of factors should turn more supportive of EM equities next year. The US dollar (USD) is a major driver of EM equities. While 2022 generally saw a sharp rise in the USD as the war in Ukraine and persistent inflation forced the US Federal Reserve (Fed) to hike rates at the fastest pace ever, we now anticipate the USD to weaken by year-end 2023. According to International Monetary Fund forecasts, after two years of narrowing, the growth differential between emerging and developed economies should widen again next year and remain in favour of the former. China, after living in a covid-free bubble for three years, is expected to fully reopen next year, lifting domestic demand and the exports of other emerging economies (although there are risks of a disorderly re-opening). Commodity prices, global trade and policy stances in EM countries themselves are all expected to have a broadly neutral influence on EM equities’ performance.

Although we have a positive view of EM equities for end-2023, the first quarters may prove challenging if the US and Europe enter recession (we expect GDP contraction of 0.2% for both places in 2023) while a sluggish decline in inflation will keep central banks on their toes. 

From a country perspective, we would seek opportunities in relatively ‘defensive’ markets first, before adding more cyclicality once macroeconomic data stops deteriorating and a pivot in major central banks’ policy comes into view. Risks to our scenario for 2023 as a whole are associated with China’s reopening, stickier-than-expected global inflation, US/China relations and the Ukraine war.