UBS: AI Investments May Shield Emerging Markets Amid Rising Energy Costs

Emerging Markets Under Pressure#

Emerging market equities are experiencing a significant downturn as the ongoing conflict in the Middle East continues into its third week. This situation threatens the growth that these markets have enjoyed over the past year. A recent report from UBS indicates that emerging markets (EM) have become some of the worst-performing asset classes globally since the conflict began, as investors adopt a cautious "risk-off" approach.

Energy Vulnerability#

One of the main concerns for emerging markets is their susceptibility to energy supply shocks. Analysts at UBS emphasize that Asia, in particular, is a major consumer of fossil fuels from the Middle East. Historically, when oil prices rise above $90 per barrel, emerging market returns tend to suffer significantly. This trend raises alarms as the current conflict escalates.

Lack of Valuation Support#

Adding to the challenges, emerging market stocks were not particularly undervalued before the conflict. Their trading prices were already higher compared to U.S. equities, leaving little room for error as geopolitical risks increased. UBS notes that the market is seeing a reversal of trades that had previously been successful, with investors moving away from oil-dependent sectors to seek safer investments.

AI Investments as a Potential Buffer#

Despite these challenges, UBS identifies a glimmer of hope: investments in Artificial Intelligence (AI). Over the past 15 months, the AI sector has been a significant driver of returns and earnings growth in emerging markets. The report suggests that the ongoing investment in AI by major U.S. tech companies may help stabilize key tech-heavy emerging markets in Asia.

The analysts believe that if the AI sector remains insulated from the conflict and further oil price shocks, emerging markets could continue to perform well. However, they warn that a swift resolution to the conflict is essential for restoring earlier growth momentum. Without it, the current volatility could lead to a long-term adjustment in growth expectations. For emerging markets to regain stability, energy costs must stabilize, and the global tech capital expenditure cycle must remain unaffected by geopolitical tensions.