1. Rotation into small caps: Small-capitalisation (small-cap) stocks in emerging markets (EM) rose in July but performed in line with large-cap peers. In the second quarter (Q2) there was a pause in their outperforming trend. The likely catalyst we see for small caps to resume outperformance centres on increased conviction that central banks will cut interest rates in the coming months as inflationary pressures ease. (Japan is the exception to this trend—raising rates at its most recent meeting). Historically, lower interest rates have benefited small-cap stocks to a greater degree than their large-cap peers, as the former tend to have higher financial and operating leverage.

2. Earnings season: The Q2 earnings season is in full swing, with South Korea and Taiwan leading the way in beating expectations. This upswing is due in part to a low base for comparison in the year-earlier period, but it also reflects the recovery in the heavily-weighted semiconductor industry group. The consensus expectation for the EM earnings growth rate in 2024 is 18% reflecting the recovery in the technology sector and the contraction in earnings in 2023, which declined 9%.

3. Interest-rate outlook: Central banks have adopted a data-dependent stance on the probability of interest-rate cuts. Investors are expecting dovish inflation data in the United States and the euro area to act as the data catalyst for rate cuts starting in September 2024. The prospect of lower interest rates has weighed on the US dollar over the past month; a weaker dollar is usually positive for EMs. However, weakness in the Chinese yuan has weighed on equity markets as investors fret about the impact of a weaker yuan on the competitiveness of EM exporters outside China.

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