Emerging markets (EM) have long been the engine of global economic growth, offering vast opportunities and presenting unique challenges. With increased geopolitical uncertainty in recent years, the outlook for these markets is the subject of intense scrutiny. These dynamic countries, characterized by rapid growth, evolving demographics, and increasing urbanization, will play a crucial role in shaping the world economy.

Investors will look back at the last decade or so and wonder whether they should consider renewed or increased exposure to emerging markets (EM). It’s easy to understand why expectations of EM are anchored to the past. From 2001 to 2010, the MSCI Emerging Markets Index outperformed the MSCI World Index by a wide margin. Yet since 2011, EM equities have significantly lagged developed markets, and many investors are now underweight the asset class.

However, even a cursory glance at the history of EM performance will quickly show that looking back to assess the future is not a particularly useful approach to take. Instead, we think investors should focus on the changing undercurrents in EM economies and markets that we expect will reignite returns in the decade ahead. As economic and political power continues to shift from West to East, several trends and challenges are likely to positively impact these markets significantly. Here we delve into the key factors shaping the trajectory of emerging markets in the next decade, and analyze the opportunities and challenges they face.

The first decade of the 21st century was an outstanding one for EM stocks fueled by unique circumstances. China joined the World Trade Organization in 2001, increasing its share of world exports and accelerating globalization. The country made huge investments in fixed assets and real estate, plus it executed a massive credit expansion unleashing a commodities super-cycle. Between 2000 and 2010, China’s GDP grew by an average of over 10.5% per year, boosting global economic activity while enriching commodity-producing EM countries and supporting their currencies. In the same period, developed markets struggled to perform, recovering from the tech ‘dot.com’ bubble bursting (2001) only to endure the sub-prime disaster in 2007. The US dollar also weakened significantly during this time further helping EM performance.

Coming out of the Global Financial Crisis (GFC) of 2008-2009, the overwhelming consensus was that US dominance after two 50% stock market crashes in one decade was over. EM countries were going to be the future. This consensus view could not have been more wrong in the decade that followed.

Between 2011 and now, the MSCI World Index significantly outperformed the MSCI EM Index. Central banks in developed markets used quantitative easing (QE) and artificially low interest rates to counter the fall-out from the GFC. This incentivized US corporate borrowing, increased leverage and stock buybacks resulting in PE multiple expansion and developed market outperformance. From 2014 onward, the US dollar also strengthened, eroding the relative competitiveness of EM exports. Commodity prices eased and geopolitical concerns intensified, from the US-China trade wars to Russia’s invasion of Ukraine, while the Covid pandemic added new challenges. China slowed down and undertook regulatory reform which undercut the fast-growing technology companies. Against this backdrop, emerging markets underperformed.

Will the next decade be a more rewarding one for EM investors? We believe so. Over the past few decades, emerging markets have witnessed remarkable economic growth, driven by factors such as demographic trends, urbanization, technological advancements, and globalization, and we expect this growth trajectory to continue. The expected recovery of EM stocks will, however, be propeled by a very different set of dynamics. Three essential trends will potentially define the next EM era.

We are in the midst of a technological revolution and emerging markets will be central to this both in terms of innovation, and as beneficiaries. Emerging markets are increasingly becoming hubs for technological innovation and entrepreneurship. Moreover, the adoption of digital technologies, such as mobile internet and e-commerce, has the potential to leapfrog traditional development stages and drive more inclusive growth, with accompanying wealth effects. Furthermore, the largest players in the global technology supply chain are in EM, especially Korea and Taiwan.

Compared with developed economies, emerging markets enjoy three distinct advantages related to adopting new technologies:

1. They likely won’t have to upend existing costly infrastructure or deeply embedded legacy systems.

2. They have young populations that are digitally savvy, have a real thirst to embrace change, and are open to experiment and implement these technologies.

3. Their governments play a key role. While the private sector in mature markets tends to drive innovation, governments in some of the larger emerging markets are actively partnering and supporting entrepreneurial efforts in new technologies as a way to nurture local talent and skills.

Key areas of impact include:

• Healthcare: In regions like Southeast Asia and Africa, leapfrogging has led to significant improvements in healthcare. For instance, mobile health apps and telemedicine services have been adopted to address healthcare gaps.

• Education: Innovative e-learning platforms and digital content delivery have transformed education in areas with limited access to traditional schooling.
  Agriculture: Precision farming techniques, mobile-based crop management, and weather forecasting apps empower farmers to enhance productivity.

• Digital payments: Lack of traditional infrastructure in rural areas has hindered access to financial services. For example, in India, the widespread adoption of mobile phones enabled the leapfrogging of banking services through the ‘unified payment interface’ (UPI). UPI facilitates interbank transactions, making credit more accessible and convenient for millions.
  

The digital revolution is reshaping emerging markets. Increased internet penetration, mobile connectivity, and the adoption of e-commerce are transforming traditional business models.

Fintech companies, for instance, are revolutionizing financial services by providing innovative solutions for payments, lending, and remittances. As digital infrastructure improves, emerging markets are leapfrogging into the digital age, creating new avenues for growth.

By 2030, it is estimated that two-thirds of the global population will reside in cities, with the majority in megacities housing more than 10 million people. This shift presents both challenges and opportunities. Governments must invest in robust infrastructure – transport, energy, water, and sanitation – to support urban growth. Smart cities, sustainable transportation, and efficient logistics networks will be critical for economic competitiveness. Infrastructure gaps remain a significant impediment to growth in many EM. Addressing these gaps through investment in transportation, energy, and telecommunications infrastructure will be crucial for unlocking their economic potential and enhancing competitiveness.

The environmental impact of rapid economic growth, urbanization and development is a growing concern in many emerging markets. Climate change, natural resource depletion, and pollution pose significant risks to long-term sustainability and could undermine economic growth prospects if left unaddressed. Transitioning to greener and more sustainable development models is imperative for mitigating environmental risks and promoting resilience. Balancing economic growth with environmental conservation is thus essential.

Many emerging countries have been pursuing green reform agendas to address environmental challenges and transition toward more sustainable development models. Some examples include:

1. China’s green reform agenda refers to the country’s efforts to transition toward a more environmentally sustainable and low-carbon economy. Key components of China’s green reform agenda include investing heavily in renewable energy. The country is the world’s largest producer of solar panels and wind turbines by a wide margin, with 90%+ of all solar panels in the world coming from China. China aims to achieve carbon neutrality by 2060, and is already investing large sums in promoting green finance initiatives and biodiversity conservation programs.

2. Brazil has been working to combat deforestation in the Amazon rainforest and has set targets for reducing greenhouse gas emissions. The country has also been investing in renewable energy sources such as hydropower, wind, and solar. Renewables compose almost 45% of Brazil’s primary energy demand, which makes their energy sector one of the least carbon-intensive in the world. Brazil’s national grid is made up of almost 80% from renewable sources.

3. India’s green reform agenda encompasses a range of initiatives and policies aimed at promoting environmental sustainability, combating climate change, and fostering green growth. India’s Nationally Determined Contributions (NDCs) under the Paris Agreement include targets to reduce its emissions intensity of GDP by 33-35% by 2030 compared to 2005 levels. The country also aims to achieve 40% of its electric power capacity from non-fossil fuel sources by 2030. While these targets are significant steps toward reducing carbon emissions, they do not explicitly aim for carbon neutrality.

4. Indonesia has set ambitious targets for increasing the use of renewable energy as part of its energy transition efforts. One of the main targets outlined in its National Energy Policy is to achieve a renewable energy mix of 23% by 2025 and 31% by 2050.
   

Achieving these ambitious goals requires massive investment in wind and solar power, EVs, smart power grids, and other green technologies. Next to their large market shares in the wind and solar market, China and Korea have large automobile and battery manufacturers with significant markets shares in the global EV supply chain.

Paradoxically, building climate resilience can be commodity-intensive, depending on the specific measures and strategies employed. Some aspects of climate resilience initiatives require significant use of commodities such as steel, timber, metal alloys, rare earth metals, lithium, silicon and plastics. Commodity-producing EM countries such as China, Brazil, Chile, Indonesia, South Africa, and Korea are likely to be economic beneficiaries of the energy transition.

The outlook for emerging markets is intricately linked to the evolving dynamics of global trade. Rising protectionism, trade tensions, and shifts in supply chains pose both risks and opportunities for EM economies. The geopolitical landscape is also evolving rapidly. Trade tensions, regional alliances, and technological competition will impact emerging markets, as will internal change. For example, India is projected to become the largest emerging market within the next decade, likely around the 2030s, overtaking China. This will be driven by population growth, robust economic growth, a demographic dividend, continued market reforms, technology and innovation, and infrastructure development.

In particular, we are increasingly seeing companies adopting the ‘China Plus One’ strategy, employed by businesses to diversify their manufacturing or sourcing beyond China by adding at least one additional country to their supply chain. This approach aims to mitigate risks associated with overreliance on China, such as rising labor costs, geopolitical tensions, or disruptions in the supply chain. Closely related is the increasing trend of reshoring and onshoring. Reshoring refers to the practice of bringing back manufacturing operations and jobs to the domestic country from overseas locations. This could be due to various factors such as rising labor costs in offshore locations, quality control concerns, logistical issues, or changes in government policies. Onshoring is similar to reshoring but focuses specifically on sourcing inputs from a domestic location rather than from overseas. Onshoring is often driven by similar reasons as reshoring, such as cost considerations, supply chain resilience, or strategic alignment with domestic markets. Both reshoring and onshoring are strategies aimed at enhancing supply chain resilience, and supporting local economies.

EM countries are essential to these shifting supply chain dynamics, particularly, India, Mexico, Indonesia and Vietnam. For example, Vietnam is benefiting from onshoring and the ‘China Plus One’ strategy in several ways:

• Manufacturing growth: Companies seek alternatives to manufacturing in China due to rising labor costs and geopolitical tensions. Consequently, Vietnam has emerged as a popular destination for relocation. The country offers lower labor costs compared to China, making it attractive for businesses looking to maintain competitive pricing while diversifying their manufacturing bases.

• Trade agreements: Vietnam’s actively pursued trade agreements provide preferential access to key markets, making the nation an even more appealing destination for onshoring and manufacturing investments.

• Geopolitical stability: Compared to some other countries in the region, Vietnam has enjoyed relative political stability, which is crucial for businesses seeking a reliable manufacturing base.

• Skilled workforce: Vietnam has been investing in education and vocational training programs, resulting in a growing pool of skilled workers. This skilled labor force is essential for industries such as electronics, textiles, and manufacturing, making Vietnam an appealing destination for companies implementing onshoring or ‘China Plus One’ strategies.