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[00:00:00] Alissa Howard: Hello everyone and thank you for joining us today. Uh, my name is Alyssa Howard. I am an Institutional portfolio manager at RBC Global Asset Management. I'm joined today by Phil Langham, our head of Emerging Market Equity, and our lead portfolio manager on our emerging market equity strategy. Today we're gonna to talk about some of the themes that we're seeing in emerging markets.
[00:00:25] Alissa Howard: Both long term and a bit shorter term as well. Um, so to get things started, um, [00:00:30] Phil, thank you for joining us today. Um, you know, I think in general what we've seen from emerging markets over the past 10 plus years is it has been an asset class that's been relatively out of favor. What are you seeing as long-term drivers for the asset class, and do you feel like we could potentially be at a turning point for emerging market at performance going forward?
[00:00:51] Phil Langham: Yeah. Um, hi Alyssa and thank you all for, for joining. So, um, I'd say if you look at, [00:01:00] uh, the relative performance of emerging markets compared to developed markets, and we go back 35 or 40 years. What's really interesting about that is that we tend to have extremely long cycles of either outperformance or underperformance going back over that period.
[00:01:19] Phil Langham: We've had two very long periods of outperformance for emerging markets and two very long periods of underperformance, including as, as you touch on the list over the last 12 years. [00:01:30] Um, if we look at the performance of emerging markets compared to developed markets year to date. We see that emerging markets have outperformed, emerging markets are up, are up roughly 25% compared to developed markets, which are up about 15%.
[00:01:45] Phil Langham: Uh, so the question is, is vis a starts of a new long-term cycle of emerging market outperformance? Our feeling is that it very well could be. When we look at these longer cycles, what [00:02:00] we see is that there are a number of important drivers for these cycles, but the two most important factors are, first of all, earnings growth, and secondly, for US dollar.
[00:02:11] Phil Langham: Now looking at earnings growth, it's been relatively flat for most of the last 10 years, but we have started to see a pickup, uh, in earnings over the last two years. This year, earnings growth in emerging markets is expected to be around 20%, and next year, 15%. And what [00:02:30] we've seen historically is the earnings growth tends to be supported by margin cycles.
[00:02:36] Phil Langham: Uh, and we very much feel that we're at the start of a new positive. Margin cycle, uh, having been in a relatively poor margin cycle in emerging markets for several years. And if you look at margins, margins over long periods of time, whatever area you look at always tend to be mean reverting. The other factor that we would say is likely, uh, to, [00:03:00] to be supportive or likely to be a very important driver for emerging markets relative to developed markets is the US dollar.
[00:03:08] Phil Langham: And historically what we've seen is the emerging markets tend to do much better in a weaker US dollar environment. That was the case between 2001 and 2010, but what we've seen in most of the last 12 years is that the dollar has been relatively strong. Generally, at the peaks and troughs, uh, the dollar are, are either tends to be very [00:03:30] overvalued at the peaks or very undervalued at the troughs as it was in, in 2009.
[00:03:36] Phil Langham: Um, in addition to valuation, we would say that there are few other factors that very much support, uh, the case for the dollar to weaken over the medium term. Uh, those factors, uh, would be the very large and growing fiscal and current account deficits in the US as well as the fact that it's very much Trump's policy, uh, to see the dollar weaken.[00:04:00]
[00:04:00] Phil Langham: We've started to see the dollar weaken this year and that's been very supportive for emerging markets. Uh, and our view would be that this is the start, um, of a longer term trend. Finally, I think the other point of the, the final point that, that, that is worth mentioning when thinking about emerging markets compared to developed markets would be valuation.
[00:04:22] Phil Langham: So emerging markets having underperformed significantly over the last 10 years, um, are now looking extremely cheap now. [00:04:30] Valuation doesn't tend to be a good short term, uh, driver of performance. If we look at valuation as a long-term driver, we see that it actually tends to be quite predictive, and particularly in a market like, like the US where we would say that the very high current valuation levels might suggest some level of caution going forward.
[00:04:52] Alissa Howard: Great, thanks. And, um, you know, you mentioned US policy and I feel like it's impossible to talk about markets, emerging [00:05:00] markets in general without thinking about tariffs and the implication of, of US trade policy. Um, globally, how do you see tariff policy coming from the US really impacting emerging markets?
[00:05:13] Phil Langham: Yeah. Um, I'd say that if you look at tariff policy, it was obviously quite confusing. Uh, when the tariffs were, were first announced, uh, in March, we've now seen, um, a lot more certainty in terms of what's likely to happen. And [00:05:30] I'd say if you look at, uh, emerging markets overall. Tariff deals have, uh, really been negotiated for all of the major emerging markets apart from India, China, and Brazil.
[00:05:44] Phil Langham: Uh, it seems as though we are likely to end up in emerging markets with tariff rates broadly between 15 and 20%, and that's roughly the same as, uh, we're likely to see, um, in, in developed markets too. So [00:06:00] for the US overall, we're gonna see, uh, tariff rates move from about two and 5%, uh, to around about 17 and 5%.
[00:06:10] Phil Langham: Um, in terms of, uh, the emerging market countries where tariffs, um, have, have yet to be negotiated. So that's, uh, India, China, and Brazil. We have more recently seen. Uh, more conciliatory remarks, um, from Trump in terms of both [00:06:30] India and China. Uh, and there's a strong possibility that, uh, Trump will meet, uh, the president of China at the end of this month.
[00:06:39] Phil Langham: Uh, and that is, as it is very much in both countries', interest to reach a deal. Um, we would say that there's a reasonably strong chance for that that will happen, and certainly that will be viewed very positively. Um, the final market, Brazil. Uh, we would say it's probably just a matter of time. The fact [00:07:00] that, uh, Trump has actually intervened, um, in Brazil has really backfired and has actually made, um, the left wing leader Lula, um, much more pop popular, and that certainly wasn't Trump's intention.
[00:07:15] Phil Langham: Um, in terms of the impact overall on emerging markets, we would say that for most emerging markets, US trade as a percentage of GDP is relatively small. Um, and there's only two or three emerging [00:07:30] markets. Where, uh, US traders, a percentage of GDP, uh, has more of than an impact of, of, of 10%. The most important market there would be Mexico, and Mexico has actually come out reasonably well.
[00:07:44] Phil Langham: Um, in terms of tariffs. For a country like China, for example, US traders, a percentage of GDP, um, is less than 2.5%. And actually if you look at how China has negotiated or they've navigated, um, [00:08:00] the trade war ever, ever since it started, uh, what we see is that China's actually been able to increase exports overall, even though exports to the us.
[00:08:10] Phil Langham: Uh, have come down and we've seen an increasing trend of emerging market exports, um, within the whole region, gradually increasing over the last 15 or 20 years. So we've seen EM to, EM, exports go from about 20% of total exports, uh, to currently between [00:08:30] 45, uh, and 50%. And for a country like China, it's been very successful also at being able to move up the value added curve.
[00:08:38] Phil Langham: Uh, and uh, if you look at China's trade surplus ever since the trade war started, um, it's actually continued to do, uh, extremely well. So overall, um, our view would be that in terms of emerging markets. Uh, the impacts, um, of tariffs is, is likely to be relatively limited. [00:09:00] Now, there is some debates, um, over, you know, who, who, who will suffer in terms of, uh, the overall tariff rate going.
[00:09:11] Phil Langham: Um, from two point a half percent to about 17.5%. In, in the us Trump would argue that, uh, it's likely to be the exporters. Uh, whereas I'd say that most economists, uh, seem to believe that, that it's actually gonna be the US [00:09:30] consumer that bears, that bears the brunt of these, uh, uh, tariffs, which are effectively tax hikes.
[00:09:38] Alissa Howard: Great. Thanks Phil. And I think what's interesting too about emerging markets is, um, really you get the diversification at the country level. You get the diversification at the sector level. It isn't the emerging markets that we had 20 years ago that was much more dominated by energy materials, much more com commodity oriented.
[00:09:56] Alissa Howard: We see, uh, an asset class with a lot higher. [00:10:00] Quality sector is really dominating, um, dominating the index at this point. Um, in particular, we've seen it, um, on the rise in IT and, and tech ai, all, all of those themes are, are very popular. Um, globally. How do you see, um, the IT sector in emerging markets, how it's implicated in global markets, and how you see kind of the valuations of that, of that segment of the market today?
[00:10:23] Phil Langham: Yeah, no, you're, you're right. Um, Alyssa, um, over the last few years, um, we've [00:10:30] gone from commodities overall representing around 45% of the index to currently, um, around about 10%. Um, at the same time, um, much higher quality sectors. So sectors like the consumer sectors, and, and it. Um, have, have continued to grow, um, and it has probably been the fastest growing, uh, major sector, uh, in emerging markets in in the last few years.
[00:10:59] Phil Langham: [00:11:00] Um, overall the quality of IT stocks, um, has, has significantly improved in, in emerging markets. It's been an area that has delivered very strong, uh, earnings growth, and we've seen emerging markets very much. Be part of the current trends, um, of, uh, benefiting from, from AI spending. Uh, I'd say that in particular, um, a lot of the companies that we would regard as being, [00:11:30] um, the picks and shovels of, of, of, of ai, so essentially the leading semiconductors, um, are very much present, uh, in emerging markets and those companies have, have, have done extremely well, uh.
[00:11:45] Phil Langham: If you look at, uh, developed market IT and compare it to emerging markets, what we see interestingly is that the valuation of emerging markets, um, it doesn't look particularly different to where it has been [00:12:00] historically. Whereas if you look at, uh, developed market, it valuations, uh, there has been a very, very significant, uh, re-rating.
[00:12:10] Phil Langham: Um. At the same time, if you look at earnings growth, uh, for emerging markets, it um, it actually looks pretty, uh, robust currently. Uh, in terms of how we view the sector going forward, uh, perhaps the most, um, [00:12:30] important development that we see, um, at the moment is the huge amount of CapEx that is going into, uh, ai, uh, largely by, uh, US hyperscalers, but increasingly by more and more other companies.
[00:12:46] Phil Langham: Uh. One of the questions that that markets are certainly starting to, uh, ask is what sort of returns are we likely to see, um, on this huge amount of CapEx spend? [00:13:00] Uh, when we saw, uh, Deepsea come out in, uh, January. So essentially China's version of an AI model, uh, that's really started to question a lot of the huge CapEx.
[00:13:14] Phil Langham: Uh, that we were seeing, we started or we perhaps saw, um, a glimpse of a market correction in it. Since then, it's clear that that CapEx is going to continue and markets, uh, have continued to very much support [00:13:30] the, the, the whole IT trade. Um, we do wonder whether going forward. Uh, as you know, perhaps, you know, it, it, it becomes harder and harder to make very good returns on this huge amount of CapEx.
[00:13:46] Phil Langham: Whether, uh, you know, we, we, we could well see, um, a correction in in it. Uh. Perhaps particularly worrying is the fact that, um, until recently, most of its, [00:14:00] IT CapEx has been funded by cap, uh, companies with very strong balance sheets. But we are now starting to see leverage being used. Um. Uh, uh, uh, to support, um, a lot of this CapEx.
[00:14:15] Phil Langham: So, our view would be perhaps to be a little bit cautious, um, on, on this area. Um, and that the margins perhaps to think about moving money out of it. And into other areas that may benefit from all this AI [00:14:30] spending. So, areas such as, uh, software, uh, uh, internet or IT services.
[00:14:38] Alissa Howard: All right. Thanks Phil. Thank you so much for answering all of the questions today.
[00:14:41] Phil Langham: Thank you.
Phil Langham, Head of Emerging Market Equities at RBC Global Asset Management, joined Alissa Howard, Institutional Portfolio Manager, to discuss the potential turning point for emerging market equities after many years of underperformance.
Langham notes that emerging market (EM) equities have had long cycles of outperformance and underperformance relative to developed market equities over the last 35 to 40 years. Over the last 12 years, developed markets have posted much stronger performance than emerging markets. However, the tide might be starting to turn, with emerging markets outperforming developed markets, roughly 25% to 15%, in the first three quarters of 2025.
Langham lists a number of important drivers for these performance cycles, with the two most important being earnings growth and the value of the US dollar. Earnings growth has been relatively flat over the last decade, with a pickup in the last two years, with estimates of earnings growth of approximately 20% and 15% in 2025 and 2026, respectively. This increase in earnings growth is likely to be supported by margin expansion. As the value of the dollar weakens, the performance of emerging markets tends to strengthen. Large fiscal deficits and Trump’s weak dollar policy are likely to continue to suppress the value of the dollar relative to other global currencies.
The US tariff policies have become clearer over the last six months, with most emerging markets having negotiated deals, with the notable exceptions of China, India, and Brazil. Most emerging market countries will face tariffs of roughly 15% to 20%, similar to those settled in most developed markets, but much higher than prior rates, averaging 2.5%. Langham believes there is a strong chance that the US and China will reach a tariff deal in the fourth quarter, which would likely be very encouraging for markets. Most emerging markets sell less than 10% of GDP to the US, with China below 2.5%, but Mexico is much more dependent on the American market. Over the last 15 to 20 years, the portion of exports from one EM country to another has steadily increased to almost 50% today, significantly reducing their dependence on developed markets. As a result, increasing US tariffs are not likely to have a broad negative impact on EM exports. Most economists believe that tariffs will largely be paid by US consumers rather than exporting companies, serving as an additional tax on consumption.
After underperforming for the last ten years, emerging market equities look cheap on a valuation basis, with improving quality of earnings over time. Conversely, today’s valuation levels of US stocks should caution investors regarding potentially lower future returns. EM exposure to the commodities sector has declined from 45% to 10%, with consumer, technology, and other growth sectors becoming larger parts of the equity markets. Technology stocks are exhibiting strong and high-quality earnings growth, with companies contributing to AI and data center buildouts earning very high returns, but with much lower multiple expansion than experienced by the large US tech companies. Langham warns that a slowdown in AI and data center capital expenditures could make high-multiple stocks vulnerable to price declines. Langham believes it may be prudent to reduce risk in high-multiple tech companies and rotate into companies that will experience productivity growth due to the large investment in new AI technology.
