Emerging market equities: Volatility, valuations, and the value case

Tom Harvey: I'll speak very loudly and I'll try to enunciate. Clearly, Devan, are you ready? Do you want me to, do you need a minute? You're good? Okay. Hello, I'm Tom Harvey with Aberdeen, and you're listening to the Emerging Market Equity Quarterly Podcast, a show that looks at what happened in the most recent quarter and provides our outlook for the asset class. Today, I'm joined by my colleague, Devan Kaloo, Head of Global Emerging Markets. Devan, welcome to the podcast. It's great to have you on. Thank you. We saw quite a volatile first quarter. We'd love to get your take on this. Markets starting off perhaps on pretty firm footing. And then obviously the conflict in the Middle East upsetting globally, not just equity markets, but most markets as some concerns about perhaps clarity of outlook and what this conflict really means. How did emerging markets fare during the first quarter?

Devan Kaloo: Yeah, thanks, Tom. And you absolutely hit the nail on the head. It was a volatile quarter. Some would say it was almost like a game of snakes and ladders. When I think about 1/4, I suppose a few things that stand out. In January and February, we saw emerging markets doing very well. And at one stage, they were ahead by 15% dollar terms, which is quite something. continuing the appreciation that we saw in 2025. But March obviously saw a big turnaround and emerging markets fell 13% and over the quarter were flat effectively over the year, over the first quarter. And that really compares to the US, the S&P 500, which is down around 4%, 5%, and indeed developed markets more generally, which are around 3%. So there's outperformance, but certainly there had been better outperformance. And I suppose from my perspective, the worst possible thing was that the absolute returns were flat. And when you think about some of the key drivers in that, it was definitely some clear things going on. So the first thing was that what drove markets higher was the continued enthusiasm around AI and AI infrastructure plays in particular. So we saw a lot of the tech names in Korea and Taiwan doing very well, and indeed in markets like China as well. In addition to that, the Korean market did extremely well in the first two months, primarily because the two big tech heavyweights, Samsung Electronics and SK Hynix, which are big index names, they did a good job of announcing value up programs which drove those share prices higher. So that was one component, certainly. The second component was that it was a period, or at least at the beginning, of easy money. And what we saw there was that the dollar weakened, much like it did through 2025. And the key concerns or the key drivers there were the expectations of Fed rate cuts, but also people looking to rotate out of US assets and into overseas assets or the rest of the world. But that all suddenly changed. And that really changed in March when the US and Israel launched an attack against Iran. And as a consequence of that, what you saw was the closing of the Straits of Hormuz and the conflict drag on for longer than the market initially expected. So first up, the markets were relatively sanguine about it, expecting a Venezuela or indeed a relatively short conflict, but as the conflict dragged on, less so. And you saw oil prices spiking up. And would that increase in concerns that there'd be consequences for growth in terms of negative growth for markets or for the economies? Secondly, that rates wouldn't be cut and may need to go up on the back of inflation and perhaps worse possible for emerging markets, a higher dollar as well. And as a consequence of that, as I said, in March, you saw these markets sell off quite sharply. So that certainly was a lot of trials and tribulations that we saw, but the market ended the quarter flat.

Tom: And so, Devan, with that as a backdrop, what did this mean for our strategies?

Devan: In terms of our strategies, we did okay relative to the index. So we kept pretty much in line, which, to be honest, was surprising, given that we went into this with a very large underweight to oil and gas and energy stocks, primarily because our view is over the longer term, there's an oversupply of oil. So the things that really helped us out were one, the fact that we have a large position in Taiwanese tech, which did very well over this period, primarily as a consequence of seeing significant earnings revisions upwards. And in addition to that, a number of stock specific points where again, earnings have come through and the markets have rewarded that. I suppose the bit which I should probably mention in terms of being a detractor has really been on the markets of India, where India was a big oil importer and has suffered as a consequence of that. Of course, as mentioned several times in the past, it doesn't have many AI plays. So as a result, you've seen money flowing out of India, which accelerated as a consequence of the conflict in the Middle East. The one other point to perhaps mention just in terms of overall drivers of the index was the correction that we saw in Korea. So the Korean market in March alone was down 25%. It still meant it was up around 15, 16% over the year, over the quarter, but it was very weak. And the primary reason for that being that we saw the foreigners and domestics selling as the Middle East conflict heated up, primarily as they de-risked and took profits. And of course, the Korean market is also one of the areas where there's a significant importing of oil. So overall, we did okay, and we're certainly looking for better returns going forward.

Tom: Great. Thanks for that, Devan. Now, I don't know if forecasting an outlook is ever an easy task. Feels like it may be unfair of me to ask it at this point, but I'm going to anyway. Obviously, some unknowns about this conflict. still happening. What are you expecting and maybe hoping for emerging markets as we move through the second quarter and into the rest of 2026?

Devan: So you're quite right, Tom. It is pretty difficult to say with any confidence on the go forward. And particularly because the outlook for emerging markets has got significantly more cloudy as a consequence of what's been happening in the Middle East. And just to remind you, we have a trifecta of issues here. So with the higher oil price or energy prices, what you have is a consequence of growth in terms of growth being revised down. At the same time, inflation is getting revised up. And therefore, as a result, interest rate outlook is for up, not down. And as a result of that, of course, you also have a stronger dollar. None of those things, as upon themselves, are good. But when you put them all together, they're certainly not great for an emerging market outlook. That said, I would still argue that our base case is that the Middle East conflict is not an extended conflict, primarily because it is in nobody's interests. And certainly the US, for its part, is keen to see a winding down of hostilities. That said, I will go on and make a few comments about some of the things for the outlook. I think I would broadly bucket into 3 components. The first is that there is divergence in emerging markets. And what I mean by that is it's not a homogenous asset class. So there are areas of emerging markets which are benefiting from these high oil prices, energy prices. So Latin America in particular is doing quite well, or should do quite well. But in addition to that, emerging markets are definitely more insulated or protected today than say in previous periods. So for instance, oil and gas accounts for a very little component in terms of electricity generation in China today. So it's less reliant, more insulated. But in addition to that, what you have is you have in many of these emerging market countries, better fiscal positions than you see in developed markets and therefore potentially better able to weather the storm that we see as a result of these higher energy prices. So that's the first point. The second reason to be optimistic about emerging markets is around CapEx. And this is a theme that we've talked about a lot, but we think that the Middle East conflict underscores the need for energy security, which means that there'll be significant investment in electrification, renewables, and indeed other things that are going to improve security for countries around the world. But over and above that, of course, we still have the ongoing themes on the AI infrastructure, as well as what we see in terms of the just the need to build out more infrastructure in general. And that is really positive for emerging markets and we think is supportive for the asset class going forward. The final reason why we're still quite optimistic about emerging markets is because we've seen a major de-rating of emerging markets over the last month. And at the same time, we've seen a significant upgrade in earnings expectations, led by tech, led by industrials. And we think as a result, the recent sell-off that we've seen creates quite an opportunity to buy some really good assets cheaper today, particularly given that we have an outlook which we think is still very robust over the longer term. So as a result, despite the cloudiness that's been created around the Middle East conflict, and indeed there are consequences from that, we do think emerging markets will emerge from this stronger.

Tom: And that feels like a good place to bring this podcast to a close. Devan, thank you very much for joining us today.

Devan: Thank you.

Tom: And thank you to everyone who took the time today to listen in. If you enjoyed today, then please download our other podcasts from our website or wherever you normally get your podcasts.