What this chart shows
Lots of attention has been paid to the concentration risk in US equities over the past two years, with the “Magnificent 7” dominating returns and index composition. However, emerging market (EM) indices have also become increasingly top-heavy. This week’s chart shows the top 10 stocks in the MSCI Emerging Markets Index as at end January, highlighting the dominance of technology stocks (navy blue in the chart) in the index — and particular concentration in just one company, Taiwan Semiconductor Manufacturing Company (TSMC) which currently accounts for over 10% of the index. Meanwhile, in the MSCI Emerging Markets ex-China Index, its weight increases to 15%. Interestingly, ten years ago, TSMC accounted for just 2.9% of the index. The market itself is also highly concentrated geographically, with China, India, Taiwan and Korea making up 75% of the index as at end January. On top of this, over the last five years, TSMC and Tencent alone have contributed to 50% of the benchmark’s return, which illustrates the effect of this concentration risk further.
Why this is important
Top holdings, TSMC, Tencent and Samsung are increasingly tied to the same AI-themes that have driven US tech giants’ returns, making EM index/passive exposure less of a diversifier in a global portfolio. This concentration also creates potential downside risk, as past regulatory interventions in China’s tech sector – such as those that impacted Alibaba, Tencent and Meituan between 2020 and 2023 – serve as a reminder that sentiment can shift rapidly.
Our active managers in the EM space, such as Aikya and Schroder EM Value, offer a more diversified approach across countries, sectors and companies. Aikya, known for its quality-focused strategy, remains underweight in tech and specifically semiconductors. While they recognise that Taiwan has produced some of the world’s best semiconductor firms, Aikya believes valuations have become increasingly difficult to justify, leading them to reduce exposure. It remains to be seen whether the enthusiasm for Generative AI can sustain the industry’s record-high valuations.
From an asset allocation perspective, we see attractive valuations in EM compared to developed markets, where large-cap equities have re-rated on the back of soft-landing expectations and monetary easing. These elevated multiples in developed markets introduce vulnerability to any negative earnings surprises, whereas EM equities trade at more appealing price-to-earnings (P/E) multiples – currently at a c30% discount. Additionally, material fiscal stimulus in China and continued easing in the US could further improve sentiment for EM equities. Concentration remains a challenge, though the combination of compelling valuations versus developed market counterparts and diversification benefits makes active management a compelling strategy in this space.
Global trade tensions intensify: The announcement of new US tariffs on imports from China, the European Union, and Japan has escalated global trade tensions. These measures have prompted discussions among affected nations about potential retaliatory actions and raised concerns over the stability of international trade relations. This development underscores the interconnected nature of global economies and the potential widespread impact of policy decisions made by major economic powers.
-
Market turbulence amid policy changes: US markets experienced significant declines, with the S&P 500 dropping 1.7%, the Nasdaq falling 2.2%, and the Dow Jones sliding 1.69% (over 700 points). Investors reacted to President Trump's aggressive policy changes, including new tariffs and spending cuts, creating uncertainty in the business sector.
-
Inflation concerns rise: January saw a surprising rise in consumer price inflation, with core inflation increasing to 3.3% from an expected 3.1%. This was partly driven by higher egg prices due to avian flu. The Federal Reserve's preferred measure, the personal consumption expenditures index, is anticipated to show a monthly increase to 0.3% but a yearly decline to 2.6%.
-
Trade tensions escalate: President Trump announced plans to impose a 25% tariff on imported automobiles, semiconductors, and pharmaceuticals, expected to be implemented on 2nd of April. This move has raised concerns about potential retaliatory measures and disruptions to global supply chains.
-
Housing market shows weakness: US housing starts fell 9.8% month-over-month in January to an annualised 1.366 million, down from December's 10-month high. Severe weather and higher costs from tariffs contributed to the decline.
-
Inflation reaches 10-month high: The UK's Office for National Statistics reported that inflation rose to 3% in January, the highest level in 10 months. This increase was driven by higher food prices, airfares, and the imposition of value-added tax (VAT) on private school tuition fees.
-
Economic growth surpasses expectations: The UK economy grew by 0.1% in the fourth quarter of 2024, narrowly avoiding a technical recession. Growth in services (0.2%) and construction (0.5%) offset a 0.8% contraction in the production sector.
-
Business confidence declines: UK firms are considering the largest layoffs in a decade as business confidence slumps with the increase's costs imposed by the Labour party. Economic uncertainties and potential trade disruptions have contributed to this decline in sentiment.
-
Potential industrial action: Oil workers and tanker drivers are contemplating strike action to protect jobs threatened by the green transition. Unite's general secretary warned of possible industrial action if job security concerns are not addressed.
-
Politics: Germany’s conservative opposition leader Friedrich Merz said he’ll move to form a new coalition government within two months after Merz’s CDU/ CSU bloc won 28.6% of the votes, followed by the AfD (far right) with 20.8%, according to a provisional vote count by the Federal Returning Officer.
-
Defence stocks surge: European defence companies saw a significant increase in market value, with the sector's total value rising by over €18 billion. This surge is attributed to anticipated increases in military spending amid geopolitical tensions.
-
Trade surplus with the US expands: The EU's trade surplus in goods with the US grew in December, with exports rising by 5.6% to €41.6 billion and imports from the US decreasing by 10.8% to €26.1 billion.
-
Inflationary pressures persist: Eurozone inflation remained elevated, with energy prices and supply chain disruptions contributing to sustained price increases across member countries.
-
Tech sector optimism: Chinese stocks rallied, with the Hang Seng Index reaching a three-year peak. This surge was driven by strong earnings reports from tech giants like Alibaba and renewed investor interest in China's AI capabilities.
-
Stable loan prime rates: The People's Bank of China maintained the 1-year Loan Prime Rate at 3.1% and the 5-year LPR at 3.6%, indicating a focus on financial stability over further rate cuts.
-
Japan’s economic growth continues: Japan's economy expanded by an annualised 2.8% in the fourth quarter of 2024, marking three consecutive quarters of growth. This was driven by strong corporate spending, though private consumption remained weak.
-
Japan trade concerns amid US tariffs: Economy Minister Yoji Muto plans to visit the US to seek exemptions for Japanese products from impending 25% tariffs on steel, aluminium,100 automobiles, semiconductors, and pharmaceuticals.
