With 96% of companies in the MSCI Emerging Markets Index finishing with quarterly results, earnings season is almost over. And the picture is not pretty – Almost half of the company has missed the analyst’s estimate, the average profit has slumped 10% compared to the previous year period and for every dollar of predicted earnings, the company brought home only 86 cents. Two years ago, an 18% rise in profits helped the EM company beat projections.
That suggests EM stocks may struggle to sustain a $2.1 trillion rally fueled by trends such as a rush to AI-related stocks and optimism about China’s rapid, stimulus-driven economic recovery. The stakes have eased as the world’s second-largest economy grapples with weak consumer demand and a price war among AI-powered money managers.
Bloomberg“The downside surprise in profit expectations is largely driven by weak earnings momentum in China,” said Nenad Dinic, equity strategist at Bank Julius Baer in Zurich. Elsewhere, “margin erosion is seen due to rising operating costs,” he said, pointing to rising wages in Brazil, Colombia, Mexico and India.
The latest earnings season marked eight quarters of a miss for the average emerging market company, based on a comparison of trailing 12-month earnings per share for the MSCI index and earnings estimates compiled by Bloomberg. The company’s results trailed investor expectations to the extent that profits would need to rise 24% next year just to meet current forecasts.
“This is definitely a risk for the EM stock rally,” said Marcus Weyerer, senior investment strategist at Franklin Templeton Investment Management Ltd. . Shares could fall 10% to 15% if the company continues to underperform, Weyerer said.
The MSCI EM index advanced 15% from January 17 to May 20, before weaker sentiment towards AI stocks led to a 4.8% decline through May 31. Tech stocks from China and the AI ​​hubs of Taiwan and South Korea led the decline.
Chinese mainland companies last quarter reported their weakest earnings since April 2018, shortly after the trade war between the US and China began. Hong Kong-listed Chinese companies posted results that showed a marginal recovery after hitting their lowest levels in at least a decade.
Stingy Consumers
Slow consumer spending is one of the reasons for poor corporate performance not only in China, but in emerging markets.
For example, Unilever Plc’s India unit reported a 5.5% drop in net income for the first quarter, missing analysts’ estimates. Behind the decline is sluggish rural demand combined with high-net-worth urban consumers shifting to other brands. A similar trend can be seen elsewhere, with Chili retailer Cencosud SA, operator of restaurant chain Yum China Holdings Inc. and Swiss-South African jeweler Compagnie Financiere Richemont SA all posted weaker-than-expected results.
Chinese consumers are “looking to preserve wealth,” said James Johnstone, co-head of emerging and frontier markets at Redwheel in London. “The fun post-pandemic revenge spree is over and people are tightening their belts.”
Unlike China, where deflation has helped companies control costs, other EM countries are struggling after three years of rising inflation. But competitive pressures and price-sensitive consumers still reeling from the economic impact of Covid mean companies can’t afford the costs.
Meanwhile, the price war in AI is putting the company’s performance under pressure. Alibaba Group Holding Ltd. dropped the prices of some services, spurring rivals to do the same. Investors objected to the discounts offered – up to 97% for some services – and reconsidered their investments in the area. Chinese tech stocks have fallen 11% in nine trading days.
BloombergOn average, operating profit margins at EM companies have declined by more than 3 percentage points over the past two years. The damage is worst for industrial companies, financial institutions, technology companies and real estate developers, Julius Baer research in Asia shows.
The Central Bank Dilemma
There is one more thing that hinders the company’s profits: A deceleration in the pace of monetary easing. While some developing countries are starting to cut interest rates by mid-2023, progress has been slow as delays to the Federal Reserve’s policy pivot and the resilience of the dollar put pressure on local currencies.
Policymakers, for now, are focused on supporting the currency. “Although there is room for rate cuts, some EM central banks remain hawkish,” Dinic said. “Poor corporate performance appears to be a secondary issue compared to broader macroeconomic stability.”
