Invesco expects emerging market (EM) equities to outperform next year, although it cautioned that markets were in for a much bumpier landing than was currently being forecast.
“If we look at four previous US recessions since the 1990s what are the assets that benefit during an early cycle? EM equities have outperformed each of those times. And so there’s no reason why we would expect this being the fifth time for US equities to be an exception,” said David Chao, global market strategist for Asia Pacific ex-Japan at Invesco.
This year’s equities market performance has largely been driven by the rally in a handful of tech stocks, notably the so-called Magnificent Seven – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – that now make up more than a quarter of the S&P 500.
Chao expects that this rally will begin to broaden out and notes that, if you exclude China from the MSCI emerging markets index, emerging markets stocks have delivered a total return in US dollar terms of around 11%, which shows good resilience.
He points to the fact that the US Federal Reserve has likely finished hiking interest rates, the US dollar is weakening and emerging market central banks in places such as Brazil and Chile have already pivoted ahead of the US as supporting the outlook for emerging market equities.
Regarding China in particular, Chao notes that this has been the real exception to the recent bout of enthusiasm in markets, as practically all assets have rallied except Chinese equities since the middle of October, although he said that they were potentially oversold at the moment.
“I think we might be in a situation where there’s too much pessimism. And certainty when there is a risk-on environment, and in China, I expect that to happen in the next couple of quarters. You should look towards those sectors that received the most amount of capital, especially from foreign funds, and that would be the tech sector,” he said.
Although Chao believes that the Fed has finished hiking interest rates, he does not share the belief in a soft landing that has encapsulated most other asset managers in recent weeks, predicting a “bumpy landing”, which would pave the way for the Fed to cut more aggressively and more quickly than expected.
He noted that this would create a ripe environment for investors to begin stepping away from cash and into longer duration, particularly assets such as investment grade credit, where yields are much higher than they have been for many years.
“It makes sense to start to lock in some of these yields, especially on the longer end of the curve. That’s why we favour fixed income in the shorter term. But as the Fed cuts rates, we think that risk appetite will increase, especially towards emerging market equities.”
Chao also sees opportunities in alternatives, notably commercial real estate due to the extent it has been beaten down this year, while he is forecasting the end of the dollar bull run, noting that the Japanese yen in particular looks cheap.