Top of the Morning: The landscape for Emerging Market Equities
The cyclical turbulence in emerging market equities is closely related to rising geopolitical tensions in the Middle East, which poses significant risks for energy markets, especially given the strategic importance of the Strait of Hormuz. Per the full note source, the potential for supply shocks could have cascading effects on inflation and economic stability globally, especially for major importers such as China and India. The desk outlook suggests a base case where any disruption may be short-lived, with partial reversals anticipated as conditions stabilize. This nuanced view stands in contrast to the immediate panic seen in market responses, stressing a strategic position amidst volatility and providing a roadmap for traders to maneuver through potential pitfalls.
What the desk is arguing
The desk argues that positioning in emerging market equities needs to take into account the volatile geopolitical landscape, particularly owing to ongoing conflicts in the Middle East. Increased risks to energy supply chains are expected to affect import-dependent countries adversely, while exporters might see marginal benefits. Per the full note source, the volatility spikes observed are symptomatic of broader reactions to geopolitical instability rather than a long-term trend.
The current view is supported by the anticipation that if the oil supply disruptions remain brief, market conditions may normalize, alleviating some inflationary pressures. Such dynamics could impact not only emerging markets but also developed economies, particularly those heavily reliant on stable oil prices.
Where it sits in our coverage
Currently, our consensus target is 1.075 for the EUR/USD, with a range from a low of 1.04 to a high of 1.12. Specific firms projecting this include:
This view aligns closely with jpmorgan, which is slightly above our consensus target, while bofa stands at the lower end, creating a narrow spectrum of expectations across the board.
How other firms see it
Several firms are aligned with the view that emerging market equities will see short-term pressures but remain resilient long-term, including jpmorgan and goldman. In contrast, firms like bofa and citi express caution, arguing for a prolonged period of volatility based on persistent energy market disruptions.
Currency pairs such as USD/BRL and USD/INR could serve as indicators of broader emerging market responses to these geopolitical events, as shifts in these currencies will likely mirror changes in sentiment towards equity markets in those regions.
01Geopolitical unrest, especially in the Middle East, may lead to short-term volatility in emerging market equities.
02Rapid shifts in energy supply chains could impact inflation globally, particularly for import-dependent economies.
03The base case remains focused on a brief disruption in oil supplies, anticipating eventual stabilization.
04Investors should watch for developments in the Strait of Hormuz affecting market dynamics.
Market implications
Traders should monitor levels around 1.075 for EUR/USD closely, alongside volatility indicators, to gauge the market's response to any escalations in the geopolitical arena. Additionally, hedging strategies against potential energy price shocks may become increasingly relevant.
Risks to this view
A protracted conflict in the Middle East that leads to sustained oil supply disruptions would pose significant risks to this outlook, necessitating a reassessment of positions in emerging market equities and related currency pairs.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we are going to revisit the landscape for emerging market equities.
We're joined by two guests for today's episode. Glad to welcome back Xing Chen Yu, Emerging Market Strategist, as well as Laura Smith, Investment Specialist, joining us today, both from the UBS Chief Investment Office. So with that, Xing Chen, Laura, thank you both for dropping by, spending some time today with our listeners and clients here on Top of the Morning.
And it's very timely that you're doing so, Xing Chen, because I know with the spike in volatility in emerging market equities, it's driven by the conflicts in the Middle East. So can you tell us a bit about how investors should position themselves? Absolutely, Dan.
Again, thanks for inviting me here. Let's talk about what's happening in Iran and the broader Middle East region and what it means for markets right now briefly. The ongoing conflict in Iran and rising tensions across the region have really increased the risk of disruptions in the energy market.
If these disruptions last, they could become a major issue for global markets. At the moment, the Strait of Hormuz, which is a critical shipping route for oil, is expected to be closed, with shipping activity dropping sharply due to security concerns. If this situation drags on, we could see more severe oil supply shocks, which would have a meaningful impact on, for instance, inflation and the global economy.
And that would put pressure on major importers like China, India, Korea, while energy exporting countries could actually benefit at the margin. That said, our base case remains that any disruption to the global energy supply will be relatively brief. We expect the recent oil spike to reverse, at least partially, once it becomes clear that transit disruptions are temporary, key infrastructure remains intact, and the need for continued military action fades.
Emerging market stocks dropped 9 percent over just two days, mainly in areas that had rallied quite a lot, such as South Korea, but today we are already seeing a rebound, and history tells us that unless there's a broader economic regime change or economic shift, markets tend to recover from these kind of geopolitical shocks. In fact, these events usually have sharp but short-lived effects on markets. So for emerging markets, we think the best approach is to stay diversified and invested, and even use this volatility to your advantage, especially after such outside corrections.
We can go into more detail on this later, but I wanted to just highlight that EM, as a diversified blog, still remains one of our top regional preferences in a global portfolio. And beyond that, we're always looking for ways to add alpha within the region. For instance, the recent upgrade to Korea.
Well, Jingchen, very helpful guidance given what a fluid geopolitical environment it is at the moment. And Laura, to welcome you into the conversation against that backdrop, is CIO still constructive on emerging market equities over, let's say, the next 12 months? What are CIO's current preferences there?
Thanks, Dan, for having me. Yes, we remain constructive on EM stocks over the next 12 months. Once again, EM stocks are back in focus.
What keeps us positive are the strong fundamentals, ongoing tech and AI innovation, and also supportive macro conditions. We really see these three elements coming together. Our outlook for the next 12 months remains anchored in expectations for earnings-led upside.
We expect EM companies to deliver 29% earnings growth this year and another 14% next year. From a valuation standpoint, valuations are attractive on a relative basis. They trade at a discount to develop markets.
And also, investor positioning is still light. So that means there is room for more inflow than our view. I think what's important to highlight is that EM firms and regions are essential to the global AI value chain.
They lead in the production of semis, memory, and hardware, and are also home to critical rare earth minerals. Increasingly, they're also serving as key destinations for data center investment. Persistent supply shortages in memory chips, we think, are likely to support earnings growth well into 2027.
And reflecting this outlook, we upgraded South Korean equities to attractive, also after a technical correction earlier this week. Fundamentals remain strong, and the market is well-positioned to benefit from the ongoing up cycle. We're also seeing positive reforms, like new rules on retiring treasury shares, which should further boost capital efficiency and valuations.
From a macro perspective, conditions remain favorable. Inflation is manageable. Currencies are relatively stable.
And central banks retain flexibility to ease policy. Dollar softness is also expected. And rising PMIs point to a supportive environment for capital flows and a manufacturing recovery.
We're also seeing policy support in key markets, such as China and Korea. And we think this can help unlock shareholder values through what are called value-up initiatives. I think, importantly, market leadership is broadening.
It's not just about tech anymore. We're seeing strength in commodity-oriented and cyclical markets, like Brazil, pockets of EMEA, and also Southeast Asia. So overall, the environment is still favorable.
Within EM, we like China Tech, China, India, Brazil, Korea, Malaysia, and Indonesia. So a lot of regions there. I think overall, given the evolving opportunity set and broader market participation that we're seeing, we see value in a diversified approach and favor broad-based EM benchmarks to be able to capture that structural upside and also navigate ongoing volatility as the cycle is evolving.
OK, so quite a few considerations there when it comes to positioning within EM equities. And Jingchen, Laura set it up nicely with respect to CIO's preferences when it comes to China. Specifically, can you expand a bit on those preferences and provide us some key takeaways from the latest Ongoing 2 session?
I know that's timely at the moment. Sure, Dan. Maybe I'll start by addressing the second part of your question.
As you know, 2026 marks the start of China's 15th five-year plan. At today's premier briefing on the government work, we got a first look at both the long-term strategic direction for 2026 through 2030 and beyond, and some specific targets for this year. For 2026, the government set a GDP growth target of 4.5% to 5% today at the National People's Congress opening, which is a bit slower than many expected.
But given the uncertainties, especially on the external front, this range gives policymakers more flexibility to focus on high-quality growth. Reviving inflation was also mentioned, with the CPI target set at 2% again. The headline fiscal deficit remains at 4% of GDP, and the planned issuance of ultra-long special government and local government bonds is also on change from last year.
And lastly, monetary policy will also stay supported. For context, China needs about 4.2%, close to 4.2% of annual growth to achieve its goal of doubling GDP per capita from 2020 levels. So while this year's specific target range is on the lower side compared to history and people's expectations, policymakers are clearly aware of the average growth needed to hit their long-term goals, while also pushing forward with reforms and high-quality development needed.
That's why innovation and self-sufficiency of PEC are, once again, top priorities, along with boosting consumption, not just through consumption subsidies, but also by investing in social welfare and raising people's incomes. Now, for portfolio positioning within China, we've been recommending focusing on China Tech, both for near-term momentum and for medium to longer-term growth potential, to complement this. We also like high-yield financials, some names in the healthcare space, and also materials exposure, and also adding some select leaders in the consumer space and power equipment as well, which can help diversify your China exposure in general.
So our focus is on those sector leaders with visible and resilient earnings, healthy and strong balance sheets, and attractive valuations. So this will hopefully capture both income and growth opportunities as China's equity landscape continues to evolve. Well, a lot of interesting developments out of China, Ben, we'll continue to monitor.
So thank you, Jingchen, for bringing our listeners up to speed. And before we close out, Laura, can you provide us some key catalysts and risks that you're watching for? What's your guidance when it comes to risk considerations in this context?
Yeah, so there are a few big catalysts and risks on our radar. I think on the catalyst side, we're watching for continued earnings growth, primarily, especially in the tech and AI space, and for policy support in key markets like China and Korea and also Brazil. Reforms that unlock shareholder value, like the value-up initiatives I was talking about earlier, are also important.
I think if we see more inflows as global investors rebalance towards EM, that could also be a tailwind. As Jingchen touched upon earlier, the main risk right now is geopolitical. Market momentum can be quickly impacted, even if the real economic impact is limited.
Uncertainty alone can prompt investors to step back and wait for clarity. So we're looking for signs around the duration of the conflict and oil prices. Other risks more broadly include a sharper slowdown in global growth, tighter financial conditions, or a pullback in tech and AI spending, which could hit earnings, particularly in North Asia.
And of course, if policy implementation in China disappoints, that could also weigh on sentiment and trigger regional outflows. A couple of other events on the horizon is the ongoing NPC meeting in China, a potential deep-seek model release, President Trump's potential visit to China, earnings season, and the next two Brazilian central bank meetings. I think the way to think about all of this is, you know, we see value in a diversified approach.
We think there's opportunity in EM, but we favor broad-based exposure to really be able to capture those domestic-driven opportunities and also to navigate ongoing volatility as things evolve. Well, Laura, Jingchen, always a pleasure. Thank you for dropping by Top of the Morning today to keep our listeners, our clients informed on CIOs' thinking when it comes to emerging market equities.
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