Earnings season is all but over, with 96% of the companies in the MSCI Emerging Markets Index having reported their quarterly results. But things aren’t looking good: Nearly half of the companies missed analyst expectations, average profits are down 10% from a year ago, and for every dollar of projected profits, companies are taking home just 86 cents. Two years ago, profits rose 18% and emerging market companies beat expectations by a large margin.
That suggests emerging-market stocks may struggle to sustain a $2.1 trillion rally driven by trends including a rush to buy AI shares and optimism about a quicker stimulus-fueled economic recovery in China.Those bets have weakened as the world’s second-largest economy struggles with sluggish consumer demand and a price war among AI companies is scaring money managers.
Bloomberg“The downside to earnings guidance is mainly driven by weaker earnings momentum in China,” said Nenad Dinic, equity strategist at Julius Baer Bank in Zurich. “The margin decline appears to be driven by higher operating expenses,” he said, pointing to rising wages in Brazil, Colombia, Mexico and India.
Comparing trailing-12-month per-share earnings for the MSCI index with earnings estimates compiled by Bloomberg, emerging-market companies have missed the average forecast by eight quarters in the most recent earnings season. The companies have underperformed investors’ expectations so badly that they would need to grow profits by 24% over the next 12 months just to keep up with current expectations.
“This is definitely a risk to the emerging-market stock rally,” said Marcus Weiler, senior investment strategist at Franklin Templeton Investment Management. “If earnings disappointment continues, that will have an impact at some point,” he said. If companies continue to miss expectations, stocks could fall 10% to 15%, Weiler said.
The MSCI Emerging Markets Index rose 15% from Jan. 17 to May 20, but fell 4.8% through May 31 on weak sentiment toward AI-related stocks. Technology stocks from China and AI hubs Taiwan and South Korea led the decline.
Mainland Chinese companies reported their lowest profits in the past quarter since April 2018, just after the U.S.-China trade war began. Hong Kong-listed Chinese companies posted results that showed a slight recovery after hitting their lowest levels in at least a decade.
Stingy consumer
Weakening consumer spending is one of the reasons for weak corporate performance not just in China but across emerging markets.
Unilever’s India unit, for example, reported a 5.5% fall in first-quarter net profit, below analyst expectations, citing weak demand in rural areas and affluent urban shoppers switching to other brands. Similar trends were seen in other companies, including Chilean retail giant Cencosud, restaurant chain Yum China Holdings SA and Swiss-South African jewellery maker Compagnie Financière Richemont SA, which also reported weaker than expected results.
Chinese consumers are “looking to conserve their wealth,” said James Johnston, co-head of emerging and frontier markets at Red Wheel in London. “The highly stimulating revenge spending that followed the pandemic is over and people are looking to save money.”
Unlike China, where deflation has helped companies contain costs, other emerging economies are struggling with three years of high inflation, but competitive pressures and price-sensitive consumers still reeling from the economic impact of the pandemic mean companies can’t pass those costs on.
Meanwhile, the price war in AI is putting pressure on company performance. Alibaba Group Holding Ltd. has slashed prices for some of its services, prompting rivals to follow suit. Investors are balking at the size of the cuts — as much as 97% for some services — and reconsidering further investment in the sector. A benchmark of China’s tech stocks has fallen 11% in just nine trading days.
BloombergOperating profit margins for emerging market companies have fallen on average by more than 3 percentage points over the past two years, with the steepest declines among industrial companies, financial institutions, technology companies and property developers, according to a Julius Baer Asia survey.
The central bank dilemma
Another factor hurting corporate profits is a slowing pace of monetary easing. Some developing countries started lowering interest rates in mid-2023, but progress has slowed as the Federal Reserve slows to shift policy and a strong dollar puts pressure on local currencies.
For now, policymakers are focused on supporting their currencies. “Despite the room for rate cuts, several emerging market central banks are remaining hawkish,” Dinnick said. “Weak corporate earnings appear to be a secondary concern compared to broader macroeconomic stability.”
