Emerging Markets in Brazil and China Buoyed by Monetary Surprises

Key Points

• September and October often represent major economic and market developments, and this quarter, Brazil and China led with surprises.   
  
• Despite global currency woes, inflation levels are nearing targets in Brazil, enabling an economy buoyed by the local equity market.   
  
• In China, the Politburo delivered radical pro-growth shifts in fiscal and monetary policies, resulting in attractive equity valuations and market opportunities. 

The composite PMI was 56.0 in July and 52.9 in August. July broad retail sales were +7.2% YoY. This has been accompanied by strong returns from Brazilian equities in local currency terms — with the local Bovespa stock index reaching a record high at the end of August.

This economic strength has not come with much inflationary pressure. The IPCA YoY inflation measure was 4.2% in the year to August, compared with 4.6% at the end of 2023 and 3.7% in the year to April 2024. The Brazilian Central Bank (BCB), has responded by moving into a more hawkish monetary stance, lifting the SELIC policy interest rate by 0.25% to 10.75% in September. This move reflects lower waning confidence that inflation will decline to their 3% target.

Finally, the interest rate outlook for the US has shifted in recent months, with a sharp decline in expected future interest rates and a 0.5% cut in the US policy interest rate in September, which has eased pressure on emerging market economies and their currencies.

Together, these developments have enhanced our preceding enthusiasm for Brazilian equities. Brazil is performing better than expected, but the weakness in the currency has offset this zeal for international investors. We believe the central bank raising rates will not significantly worsen the outlook for local equities but will rather substantially improve the outlook for the currency (as does the US cutting interest rates). We continue to think Brazil equities can deliver strong USD returns, but now expect a larger share of that to come from the currency relative to the local equity market.

Meanwhile, in China, the Politburo convened in September outside its typical April/July/December timetable, and the resultant policy statement also delivered a dramatic surprise for markets. The meeting underlined a critical shift in the Politburo’s priorities, including to “stop the decline in housing” and “‘increase lending to white-listed projects.” In addition to the focus on housing, there was the QE-like target to “ensure necessary fiscal expenditures” through ultra-long special sovereign bonds and local government special bonds. 

The People’s Bank of China (PBoC) had already carried out a number of monetary policies before the Politburo announcement, with surprise cuts in the policy interest rate, the banking system’s Required Reserve Ratio, and the outstanding mortgage rate. PBoC also announced RMB 800 billion of support for the stock market. Crucially, alongside these measures, the Politburo provided subtle updates to its monetary policy language, including replacing the word “prudent” with “‘forceful” indicating the direction of cuts in policy interest rates.

The market reaction was visceral. The Hang Seng China Enterprises Index of Hong Kong-listed Chinese stocks rose 26% in six trading days, while the Shanghai Composite Index rose 21.9% in the same period. Consumer and property names, including the bulk of Chinese holdings in our portfolio, led the rise including eight names that rose more than 40% between 23rd September and 2nd October.

During the grinding slowdown in the Chinese economy since 2020, there have been previous policy-driven market spikes (including in October 2022 and January 2024). The magnitude of these occurrences aligns with previous episodes, albeit are moving at a faster clip. What matters going forward is whether the new policies reverse current economic trends. Our process involves paying close attention to emerging economic data precisely because of turning points such as this.

Even amid these movements, we consider China’s low inflation, large trade and current account surpluses, earnings growth in parts of the equity market, and attractive equity valuations as reasons to maintain holdings in Chinese equities. We have been overweight China since April 2024, have been rewarded for that stance in recent weeks, and continue to be on the look for opportunities in China.

Sources: JOHCM/Bloomberg.

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Source: JOHCM (unless otherwise stated.)