The Strength of Emerging Markets Amid Dollar Weakness

Understanding Dollar Weakness and Its Impact on Emerging Markets

Periods of dollar weakness have historically delivered impressive returns for emerging markets (EM). As the dollar continues to soften, this trend appears to be re-emerging, creating favorable conditions for many emerging economies.

Why Dollar Weakness Matters for Emerging Markets

Over the last 30 years, there has been a clear pattern: periods of EM equity outperformance coincide with dollar depreciations. When capital flows from the U.S. to global markets, emerging economies typically experience stronger currencies, reducing import costs and easing financial conditions. This combination boosts both domestic growth and asset prices in EM nations.

Despite global trade policy uncertainties, activity levels in emerging economies have remained stable, suggesting a potentially supportive environment akin to previous positive cycles.

Current Economic Environment

• Inflation Easing: Many emerging markets are experiencing a decline in inflation, allowing for improved purchasing power.
• High Interest Rates: Central banks can maintain higher interest rates while still having the flexibility to stimulate growth.
• Valuation Discounts: Emerging market equities are trading at a noticeable discount compared to developed markets, providing investors a unique opportunity for returns and portfolio diversification.

Identifying Opportunities in Emerging Markets

Grouping Emerging Markets by Structural Positioning

Emerging markets vary significantly in their structural positioning, which influences their performance prospects during dollar weakness:

1. Developed Financial Markets

Countries like Taiwan, Korea, Hong Kong, and the UAE showcase well-developed financial systems. Although their currencies have appreciated alongside dollar depreciation, their dependency on exports may make it challenging to maintain these gains in the short run.

2. Dollar-Anchored Economies

Saudi Arabia, Thailand, and Malaysia possess substantial dollar reserves and have managed exchange rates tied closely to the dollar. Their performance is more sensitive to external dollar fluctuations than to their own economic policies.

3. High-Growth Economies

Brazil, Mexico, Indonesia, and India are ideally positioned to benefit from the current cycle. The combination of stronger currencies and lower inflation may prompt central banks in these countries to lower interest rates, creating a favorable atmosphere for equities.

4. China’s Unique Position

China’s tightly managed currency reduces its reactiveness to external dollar dynamics. Future economic health will largely depend on the scale of stimulus implemented by policymakers.

The Case for Investors in Emerging Markets

Economic growth in EM has outpaced that of developed economies for the past decade. Yet, equity market returns have not reflected this growth, which aligns with historical patterns of cyclical returns in the emerging market equity space.

The Investment Opportunity

With the dollar weakening and conditions in many emerging economies improving, the historical trend of robust returns is set to repeat itself. Emerging markets remain largely overlooked, and their equities are still available at a discount compared to developed markets. This scenario not only offers substantial return potential but also provides enhanced diversification benefits for investors.

Conclusion

As we observe a potential resurgence of dollar weakness, emerging markets present a compelling opportunity. Investors should consider the unique dynamics and valuations these economies offer to position their portfolios for future gains.

Ada Chan is the senior fund manager of JOHCM Global Emerging Markets Opportunities. The views expressed here are not to be construed as investment advice.

Key Takeaways:

• Dollar weakness supports emerging market growth and equity performance.
• Structural positioning varies among emerging markets, providing different levels of opportunity.
• Emerging markets trade at discounts, making them attractive for investors seeking returns and diversification.

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