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Stephen Rudman: Good day, this is Stephen Rudman. I'm part of the Ashmore New York based client facing team. Thank you for joining the Ashmore "EM in 10" with Global Head of Research, Gustavo Medeiros. Lots of news coming out of the first month of the year here in January, so let's get right to it. 

Question one, Gus: obviously with quite an impressive January in terms of performance and a continuation of a rally that we saw in both November and December, what are your views and what are you thinking as we've just finished up the month of January?

Gustavo Medeiros: Well, first, thank you for hosting the first "EM in 10" of the year. My views personally haven't changed. As mentioned in my weekly research two weeks ago, the thesis we put out at the beginning of December last year (of a year of two halves), is holding, particularly the second geographical connotation, with China bouncing up and growth accelerating in they reopen their economy, while the western world is still going through a recessionary process related to the very strong tightening of monetary policy after the US Federal Reserve (Fed) policy of higher interest rates. 

But if you look at the performance year-to-date, it's no surprise that with China reopening its economy even earlier than we expected when we published our research – and much earlier than most sell-side research expected –, Chinese stocks are actually outperforming quite significantly. That is driving the MSCI EM index, or Emerging Markets (EM) stocks in general, to outperform globally – to outperform the S&P 500 and also to outperform broader markets, European stocks, for example. I think that's a very interesting beginning to the year. Our thesis that EM is likely to outperform on the back of better GDP growth performance is playing out quite nicely. 

The other part of the thesis of the year of two halves is obviously the first half of the year would be choppy. It obviously doesn't feel like that considering the massive rally year-to-date. This has continued even after the Fed, European Central Bank (ECB) and the Bank of England (BOE) announced their monetary policy changes in February. We have the S&P up 7.4% and trading close to 4,200 levels.

Now, my view and my thesis is that we're still going to have a choppy environment. It's not playing out so far, but I think it still stands. In a way, it's very hard for us not to see a recession given what's happening in the labour market, and how aggressively inverted the yield curve remains in terms of the United States, and given the signs that we're getting from other markets. 

It's interesting that despite the fact that China is reopening, energy markets are not catching a beating, one of the reasons why inflation remained relatively low. So, we are in a bit of a constructive model where yields have declined quite significantly from their peak. And equity managers are basically using a lower discount rate and bringing a higher net present value. What I fear is that at some point, lower rates will come because of a recession this year, and that's when you can have interest rates declining but where risk assets are not trading in a choppy manner. 

I'm very confident that even if we do get a change in the environment from bullish to a bearish, EM assets are still likely to outperform, because EMs have had a very different time in terms of monetary policy. China, which is leading the outperformance so far in EM equities, did not do any monetary policy easing during COVID, and did not do any aggressive monetary policy tightening in 2022 either. So, we have a very different cycle playing out in emerging markets on the fundamental side, and valuations are still extremely attractive. So, the thesis that EM outperforms during 2023 remains very much intact. The timing of that thesis looks a little weak at the moment, but we're sticking to our guns, saying that we're still going to have a choppy market environment. At the end of the day, this should be an opportunity for you to add exposure to the asset classes that are still relatively attractive.

Stephen Rudman: Gus, thank you. As we move forward, does the rally still have legs here? As you said, it may be bumpy. Obviously, the question our clients is when to allocate or to continue building their EM position and what might be the best way to do that, as opposed to sitting on the side-lines?

Gustavo Medeiros: Good question. We've been getting some client questions specifically related to China. Hang Seng shares, the shares that trade in Hong Kong, bounced more than 50% from their absolute lows in September/October. Did investors miss the rally? The answer is no, I don't think so. I think this rally is very likely to have more legs.

In very simple terms, you want to buy stocks when stocks are relatively attractive and when monetary policy – or policymakers – are on your side. They've decided not to fight inflation but to stimulate the economy, and monetary and a fiscal policy is trying to incentivise growth. And, after a year-and-a-half where China has been tightening policy, particularly via macroprudential policies, the three red lines of the real estate sector, and also the technology sector where a number of administrative measures have been working, this has been a super-strong headwind for the sector. 

Now China has turned away from the lockdown policies and zero-COVID, across all these three key metrics, and we are getting a much better environment for Chinese technology companies. The highest profile technology companies in China that were having specific points of contention with the government, have reached agreements on these contentious points. An initial public offering (IPO) for Ant Group is being discussed again after the Chinese government was allowed to get COVID shares, for example. Alibaba bounced close to 100% from its lowest point to the highest. But the valuation there remains extremely attractive, and if policy is stimulative, there could be many, many moons to this leg. 

Just think about the massive relief rally that we had in the western world when economies reopened post-COVID. That hasn't played out yet in China. Saving rates in China are extremely elevated, because people haven't been buying real estate – the biggest item that they've bought over the last 10 years. So, when the economy reopens, there's going to be a huge amount of pent-up demand on the consumption side of the story. 

Obviously Chinese tourism is going to play a role, and that's going to mean a mini-boom for EM Asia. At some point, that is going to feed into the broader Asian economies, in our view. 

Now, if investors want to be very specific, should they trim a little bit of some of the positions bought in October at this moment? Potentially yes, but this is such a tactical trade that we don't think it makes sense for asset allocators to try to do such very specific trimming. 

The big picture here is very important. Since 2010, US stocks have been outperforming everything. Last year, US stocks underperformed EM equities ex-China, and year-to-date, US stocks are underperforming as well. So, it's an interesting paradigm shift when you have the former market leader underperforming, and it happened first in a bear market environment last year. Again, we have to exclude China because it had so many headwinds last year. But now with China reopening and bouncing back I don't think that the MSCI EM is very likely to be in a much better environment. And as I mentioned, valuations are still extremely attractive. 

So, Stephen, you have to think about EM equities or Chinese equities and EM equities more broadly, as at the beginning of a new bull market cycle. Obviously, this gets muddied if we do get a recession in the developed world, which remains the base case scenario. But again, these are assets that should be outperforming even if we get some choppiness ahead during this year.

Stephen Rudman: Agreed, and I think that's the point. I think our investors generally are strategic, and have at a minimum, a medium to long-term time horizon. In retrospect, it would've been great to have big placements of allocations 90 days ago, but it does not change the long-term theme. Just be prepared for some bumpiness and so forth. Let's do one last question, because it's certainly been the story of the week. We've had busy days for the Fed, the BOE, and the ECB. Why don't you share your thoughts as they got their 2023 campaign underway, and what further to expect?

Gustavo Medeiros: Yes, well it's interesting, because all central banks tried to convey a hawkish message. In particular, the statement from the Fed confirmed the need for ongoing 

policy tightening, which suggests they're going to hike policy rates by another 25 basis points at the next meeting, and potentially leave the door open for May. In fact, it's going to be very hard for the Fed not to hike in March, which is not fully priced in by the market at the moment. 

The ECB increased rates by 50 basis points and pre-committed to another 50 basis point hike at their next meeting. The BOE also raised rates by  50 basis points and said that they're going to have to keep hiking rates. Nevertheless, we saw a tremendous rally on global rates during Fed Chair Jerome Powell’s speech. That's when the rally on Treasuries started, and that fed through the rally in risky assets, so that led to a massive, to another tremendous short-squeeze in global equities.

Dare I say it, we might be seeing peak 'Goldilocks' here. It's almost like the markets are trying to front run and saying that if the last hikes are going to be in March or May, then we can already go ahead and start partying, because the next move is going to be policy rate cuts. But hang on a minute, policy rate cuts most likely come together with a recession at this part of the cycle. Therefore, I think that the equity market feels like it has run ahead of itself a little, pricing a very strong disinflationary picture that we've been seeing again, since November. 

So, I'm still a cautious in terms of conveying a message to portfolio managers and possible asset allocators that is the time to increase beta, and that we're ‘off to the races’ to a global bull market across the board. I don't think that that's the case. 

On a relative value basis, you should be playing EM debt remains very attractive, as you get 8% yield to maturity. If we get a rally in rates, obviously that is a part of the asset class that is performing extremely strong as well, and EM equities are outperforming, so the relative value is very, very clear. 

And if you don't want to be cute on the timing, I think that on a three-year basis these asset classes will perform extremely well, even if we do get a recession towards the second half of the year. This is because with a recession we're going to see a proper central bank pivot, which is when actually you should be buying risky assets. 

So, it's interesting we got hawkish messages from the three largest central banks in the world, but rates rallied nevertheless, as a continuation of the squeeze we've seen since October when inflation started to decline and people started to price in peak inflationary pressures. Again, while we always have to respect the market, at some point, markets typically get ahead of themselves. 

And to my last point, for 10-year Treasuries to go much below 3.3% with the Fed funds rate at 5.25%, which is where the Fed is signalling we're going to get Fed funds rates after March, again, you need a recession and you need at least a very, very strong economic deceleration. I think that scenario is not priced in at all in risk assets when looking at the price to earnings ratio of the S&P 500, for example. Also expected earnings per share at the current levels is  not consistent at all with a recession. So again, it gives an opportunity for a tactical, technical positioning.

Stephen Rudman: Excellent, thank you, Gus, I'll describe that as instead of cautiously optimistic, optimism with some caution, if people can parse that nuance. 

Gustavo Medeiros: Yes, or we're super optimistic in the right asset class, but nuanced overall beta in the global portfolio.

Stephen Rudman: Well said, and thank you. I know it's been a really busy month, although  obviously an encouraging one for markets in general, but again, with caution. As always, thank you. For all those who have joined and are watching, we appreciate your time and effort. As always, if there are any questions, please don't hesitate to reach out to your Ashmore representative. All be well, and we'll be back with another instalment of "EM in 10" next month, thank you all.