In 2023, major global equity indices delivered double-digit returns as inflation cooled and central banks signalled likely interest rate cuts in 2024. Developed markets like the US, UK, and Japan, which faced difficult economic conditions in 2022, saw a turnaround.
The US market had fallen by 19% in 2022, underperforming India’s Nifty 50, which rose by 4.3%. However, 2023 saw a reversal, where developed markets outperformed the broader indices of major emerging markets. However JP Morgan believes that in 2024, “Demand for diversification away from developed countries and GDP growth divergence will make emerging markets attractive.”
We explore the valuation perspective of major emerging market indices after their positive run in 2023.
Even after a rally in 2023, major emerging markets are still trading near or below their historical P/E levels. China is the largest economy in Asia accounting for one-fourth of the MSCI EM index, a benchmark for global fund flows into emerging markets. The market was rattled by public property busts in 2023 that led to the defaults of many prominent developers like Country Garden. Stimulus measures by the Chinese central bank have not had a significant effect on economic recovery, leaving the growth outlook grim. As a result, the Chinese benchmark index, Shanghai Composite (SCI), fell 3% in 2023 and is currently valued at 8.4 times its earnings.
Countries like China, South Korea, and Brazil are trading below their historical P/E, making their valuations justifiable. Trading at less than 10 times their earnings, China and Brazil could be undervalued by global fund managers.
Mexico’s MEXBOL, on the other hand, delivered strong returns of 18% with a P/E of 12.1 but still trades below its historical average P/E of 15. Similarly, Brazil’s IBOV has delivered high returns in 2023. South Korea’s KOSPI index recorded a 14% rise. The contagious effect of the showdown in China is visible on Hong Kong’s HSI, which dropped by more than 13% in 2023 but is still valued fairly at a P/E of 15, its 10-year average.
Indian indices valued at a premium, while other major emerging markets fairly valued
India (Sensex) and Taiwan (TWSE) rose 18% and 26%, respectively, in 2023. As a result, India and Taiwan’s benchmark indices are trading above their historical averages. The global chip manufacturing boom has benefitted TWSE, as the index is dominated by tech stocks. It is trading at a premium of over 15%.
The Indian benchmark has a price-to-earnings ratio of 24, which indicates that it is overvalued compared to the 10-year average P/E of 18.9, implying a 26% premium. High tax collections and huge government spending have helped Indian markets grow, especially the small and mid-caps. The BSE Midcap and BSE Smallcap indices shot up by 44% and 47%, respectively in 2023, taking Indian indices’ valuation above the average. However, India’s Nifty 50 is trading at a 12-month forward P/E of 19, which is slightly lower than its 10-year average of 20. In contrast, the MSCI EM index, a benchmark index for emerging markets, is trading at 11.2 P/E.
Emerging markets well positioned to attract global fund flows
Emerging markets come with unique political and economic challenges. As 2024 is expected to bring interest rate cuts around the world, emerging markets are likely to attract huge inflows from developed markets. This year, asset allocators must pay attention not only to economic indicators of countries but also to political stability, especially with many emerging markets like India and Taiwan facing elections in 2024. The result of the US presidential elections in November will also have an impact on global markets. In India, a strong win for the BJP government at the center could be seen positively. The Reserve Bank of India has also kept a steady hand on inflation, another positive sign for global fund managers.
Indian markets are bracing for volatility in this election year, and its premium valuation hinges on strong corporate earnings in Q3FY24. Chris Wood, the global head of equity strategy at Jefferies LLC, says, “If the ruling BJP faces a surprise defeat in the parliament elections, as happened in 2004, then I would expect a 25% correction if not more.”
Currently trading at 24x its earnings, India is one of the highly valued major equity markets. Despite this overvaluation, expansionary monetary policies in developed countries will reap the benefits of falling interest rates, lower borrowing costs, and higher economic growth.
