A glimpse back at the first quarter
It would be an understatement to say that it was an interesting first quarter in 2023. Banking sector turmoil, the war in Ukraine, and U.S.-China relations, both with and without weather balloons, have been only several key elements having impacted markets on a global level. At abrdn, we remain focused on three key issues effecting emerging markets: First, the China recovery. Second, the financial contagion. And lastly, the further likelihood of a US recession.
China recovery rather ho-hum
Investors may have been left feeling a little underwhelmed at the strength of the recovery coming out of China since having lifted COVID restrictions in October 2022. Unlike what was witnessed in the West once restrictions were eased and met with a significant economic recovery and strong response by consumers – we haven't seen that same effect in the first quarter of 2023. Perhaps the key, from our perspective, may be several factors. China's government remains committed to stabilizing their property market before involving the private sector in driving economic growth. The Chinese government has been doing more to try and reassure the private sector, even phoning investors that they're indeed back and open for business. So, while the recovery story has been somewhat lackluster, we do look forward to seeing more to come on that front throughout 2023.
Risk contagion
The other aspect from the first quarter has been the financial contagion and knock on sentiment toward banks and financial institutions, particularly in developed markets. We did see a significant sell-off in some of the financial names, particularly those in parts of Asia, that may have been due to behavioral investing: the fear of the unknown. Something we have grown to almost expect as a result of previous financial crises. Most investors have, however, carried on, but when looking at the underlying conditions within many of these banks in emerging markets, it is very different from what we're seeing in developed markets.
Dollar on the decline?
When we look at growth in the US, we look at the yield curve, which indicates that the US economy is heading toward recession. But would a US recession, entailing weaker corporate profits in the US, for certain lead to a weaker global economy? We believe it could make a case for assets outside of the US outperforming over the next nine months or longer. Therefore, the US recession story is important in regard to both the state of the dollar, but also the relative earnings profile of the US versus the rest of the world, specifically emerging markets. Fed market pricing has already begun to suggest a deeper cutting cycle, which, as the chart below illustrates, the dollar index has already begun to reflect.
Chart: The US dollar index suggests a deeper cutting cycle
Source: Bloomberg, April 2023
What's next for emerging markets?
One of the big issues coming from Q1 that we do foresee is the likely slowdown in the second half this year going into next year and what effect it will have on bond market growth in the US. We believe the financial contagion issue, as a result of the banking crisis, has further increased the likelihood of a US recession. A recession that would mean a peak for US interest rates and could be accompanied by dollar weakness. This, we believe, remains a positive backdrop for emerging markets. However, on the flip side, is inflation. Remember the adjective that has lately been associated with inflation is sticky meaning it's not going to come down as quickly as anticipated, or as some may hope, and that may come with some surprises.
Lastly, we believe the Chinese recovery will begin to start ramping up from slack to full throttle, due to the property market recovering. Property prices, a key driver for Chinese economy, are again on the rise, which provides indication that consumer confidence is returning. As far as emerging markets and the products of attractiveness, there is an underpinning to some industrial cap. Given the positive trends in the global renewable energy story with corporate expenditure extracting minerals from the ground than building things out occurring in most emerging markets, we see this as compelling reason to continue to invest.
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