The return of the e-merging markets

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The writer is chair of Rockefeller International. His latest book is ‘What Went Wrong With Capitalism’

At the height of the internet boom in 2000, Wall Street salespeople tried to add a digital lustre to emerging stock markets by rebranding them as “e-merging markets”. A quarter of a century later, amid the euphoria for AI, a similar story is unfolding. The same tech stars, South Korea and Taiwan, are driving a kind of retro rally. Over the past year, these two nations accounted for 75 per cent of emerging market returns, and most of those gains came from just three stocks — all big makers of semiconductors.

Korea and Taiwan have arguably sprung to the fore as the biggest beneficiaries of the global AI boom. Amid tight supply, AI-driven demand has driven up prices for semiconductors made by TSMC, Hynix and Samsung to record levels. With America’s big tech companies on course to invest $700bn in AI capex this year, their free cash flow is disappearing, but their heavy spending is boosting the profitability of the three north Asian giants. Together their profits are on track to top those of Apple, Amazon and Alphabet combined. Samsung is expected to increase operating profit more than sixfold this year to around $185bn, surpassing every member of the “Mag Seven” American companies other than Nvidia. 

As a result, with a boost from large and avid populations of local retail investors, these markets have gone parabolic in recent months — as was the case in 1999-2000.

Much has changed in the intervening decades. While the leading creator of stock market indices, MSCI, still classifies South Korea and Taiwan as emerging markets, they are developed countries in every other way. They now have per capita incomes over $35,000, which is more typical of developed than developing nations. They have escaped the “middle income trap” and sustained relatively high growth rates for decades by staying on the cutting edge of every tech revolution, both ranking top three in the world (alongside Israel) for R&D spending as a share of GDP. 

That’s what set up South Korea and Taiwan to thrive in semiconductors, a cut-throat industry prone to busts and booms, none sharper than the one under way now. The recent surge has made this boom the most powerful of the past 10 global up cycles, with global semiconductor sales up more than 60 per cent over the past year.

Investors are pushing the big north Asian chipmakers up the ranks of the world’s largest companies by market cap. TSMC is the most widely held stock, owned by 92 per cent of global equity funds. In comparison, Microsoft, the most widely owned US stock, is held by 84 per cent of those funds.

It’s no secret that mega tech stocks have been dominating — some would say distorting — the US market for years. Today, by some measures, emerging markets have grown even more concentrated than the US, with the leading five stocks accounting for a greater share of the index. While the top US stock (Nvidia) represents 8 per cent of the US index, the top EM stock (TSMC) accounts for a record 13 per cent of the EM index. In fact, based on MSCI methodology, TSMC now constitutes a larger share of the MSCI EM index than all the stocks in India put together. 

It wasn’t supposed to happen this way. China was expected to be the second biggest beneficiary of the AI boom after the US. Instead, still struggling to figure out how to profit from AI, Chinese giants led by Alibaba and Tencent have been registering paltry stock price gains compared with their counterparts in South Korea and Taiwan.

A rally of this scale raises the question: when will it end? A landmark study found that when a country or sector outperforms its equity index by more than 150 per cent over two years, a sharp correction is highly probable in the following two. And in emerging markets, the semiconductor sector has beaten the MSCI index by more than 180 per cent over the past two years. That puts them firmly in the danger zone, if history is any guide. 

And outside of tech, not much new is happening in South Korea and Taiwan. They share burdens common to developed economies, including ageing populations and high consumer debt, which are crimping domestic demand. South Korea’s economy is now growing at an unremarkable pace of around 2 per cent. As a smaller and less diversified economy than South Korea, Taiwan is more directly affected by the semiconductor boom and is expected to grow much faster, hitting a pace near 7 per cent this year.  

When the AI arms race cools and demand for chips subsides, the spotlight on these nations will fade. For now, though, the e-merging markets are again having a moment.