These two regions are tipped as winners in 2023. Here’s how to profit

Morgan Stanley expects more than 10% returns next year for these two markets. We explain why, and name some fund ideas. 

Two unloved stock market regions have been tipped to top the tables next year and could generate more than 10% returns.

Emerging market and Japanese shares are Morgan Stanley’s top stock market picks for 2023, with the investment analyst also saying that US stocks will continue to lag international peers.

“Valuations are clearly cheap and cyclical winds are shifting in favour of emerging markets as global inflation eases quicker than expected, the US Federal Reserve stops hiking in January (and starts cutting in at the end of next year), and the US dollar weakens.

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“The MSCI Emerging Market index typically outperforms in early cycle, and we see 12% price returns in 2023,” the bank said.

In emerging markets, the bank says that “early cycle” stocks – referring to shares that will do best when the economy begins to show signs of recovery – will be a good place to be invested. These include technology hardware and semiconductor stocks.

Morgan Stanley reckons Japanese shares will grow a similar amount, with the TOPIX index rising 11% in 2023. 

It says that stock markets are “forward looking”, meaning they price in positive and negative news even before an event’s consequences are felt in the economy.

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“Markets typically move three to six months before the economy. This could mean a bounce in the next three months as our economists forecast a recovery in the second half of 2023.

“New cycles also bring new leadership and after the longest emerging market equity bear market on record, we see a strong 12% price recovery over 2023 in our base case, albeit with the widest bear/bull skew of the major regions.

“The TOPIX can also perform well at the start of a new cycle, particularly from low starting valuations, and we forecast 11% returns in yen and 16% in dollars as our base-case scenario.”

In Japan, Morgan Stanley says companies that benefit from an economic reopening and the movement of supply chains away from China would be the biggest winners, and in emerging markets semiconductor and technology hardware stocks, alongside financials and industrials, were its top picks.

India is now the second-largest market in the emerging markets index, with a 16% weight, double what it was a year ago. China has fallen from 43% to 28% of the index.

Morgan Stanley backs India to keep outperforming. It is, however, neutral on Chinese shares, even after a sharp drop in values over the past year. Morgan Stanley says there is a wide range of possible outcomes for China.

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Japanese and emerging market returns have been underwhelming over the past decade. In sterling terms, the MSCI Emerging Markets index has returned jut 65% over the past decade, while the TOPIX has risen 143%. In contrast, global shares have risen 234%.

Morgan Stanley only expects 3% returns in Europe next year, and has a price target of 3,900 for the S&P 500 index, suggesting a 1% decline from current levels.

How to invest in emerging markets and Japan

Investors have a range of fund, investment trust and exchange-traded fund (ETF) options to access Japanese and emerging market shares.

Over the past year, it has been a painful period for investors with funds investing in these two regions, however for new investors, buying today is arguably a better entry point given that valuations of companies have become cheaper.

interactive investor’s Super 60 list of investment ideas includes Fidelity Index Emerging Markets and JPMorgan Emerging Markets investment trust.

For more specialist access, investors could look at Fidelity Asia or Fidelity China Special Situations.

Interactive investor’s ACE 40 list of sustainable investment funds includes iShares MSCI EM SRI ETF (LSE:SUSM), which tracks emerging markets, but is tilted towards more sustainable shares, and Stewart Investors Global Emerging Markets Sustainable.

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Lindsell Train Japanese, Jupiter Japan Income and HSBC Japan Index for Japan are recommended by interactive investor for Japanese shares.

Investors after a bargain could look at picking up an investment trust trading at wide discount to its net asset value. Investment trust shares trade on the stock market, so investor pessimism or optimism can cause divergence between the cost of shares and the real value of the assets they own.

The widest global emerging market trust discount, as of 1 December 2022, is Barings Emerging EMEA Opportunities (21% discount), followed by Fidelity Emerging Markets (15%) and Utilico Emerging Markets (14.5% discount). Super 60-rated JPMorgan Emerging Markets is on a 10% discount.

In Japan, abrdn Japan Investment Trust and Schroder Japan Growth trade at 10.5% discounts, and Atlantis Japan Growth , which invests in smaller companies, is on an 17% discount.