A rebound for emerging markets in the 2020s?

After a difficult decade, we see causes for optimism about emerging markets in the decade ahead.

Feb 5, 2020 | Justin Leverenz

The teens proved to be a difficult decade for emerging markets. That setback came after EM stocks delivered strong returns in the first decade of the 2000s, as the MSCI Emerging Markets Index outperformed the S&P 500 by 11% on an average annual basis from January 1, 2000 to January 1, 2010. But over the past decade, EM equity returns proved to be disappointing, as the major EM equities index underperformed the S&P 500 by 9.8% on an average annual basis from January 1, 2010 to January 1, 2020. (Figure 1)
 

Figure 1: EM equities’ performance over the past decade, relative to developed markets
Cumulative returns and compound annual growth rates (CAGR) of indices from January 31, 2010 to January 1, 2020
 

Source: Source: BofA Global Research, MSCI, FactSet, Bloomberg, as of 1/1/20. Returns assume dividends are not reinvested. Past performance is no guarantee of future results. An investment cannot be made directly into an index.


Two key factors drove that poor performance. First, the economic growth rates in emerging markets overall didn’t recover after the global financial crisis of 2008-2009. The second key contributor was the collapse in commodities prices of 2014-2015.
 

Key themes of the past decade
 

The poor fortunes of the emerging markets during the past decade also put to rest many of the assumptions investors had made about EM.
 

  • The BRICS couldn’t continue on a strong path of economic growth and development.

    The notion that all of the BRICS countries – Brazil, Russia, India, China and South Africa – were on the same development track proved to be overly optimistic.

    Growth in Russia, Brazil and South Africa came to a halt, as the economies were adversely affected by weak commodity prices. India continued to be in a deep economic slump. All four of these countries were also plagued by some combination of weak domestic savings, high levels of inequality with low social mobility, insufficient fiscal capacity to spur their economies, and low degrees of economic openness, the latter of which negatively impacts the ease of exports and imports.

    China’s growth rate, which had been as high at 9.5% in 2011, slowed through the decade and hovered in the 6% range by the end of the decade.
     
  • Even with all its promise, China’s economy couldn’t maintain a pace of near double-digit growth.

    The slowdown in China seemed to catch some by surprise. While China is still among the world’s fastest-growing economies, it couldn’t sustain the torrid pace it had set previously. Some of the contributing factors included a saturation in its share of the global export market and the fact that its real estate and automobile sectors had reached the peak of their cycles.

    While spending from the government helped bolster the country’s flagging growth, those fiscal interventions proved to be unsustainable in the medium term.
     

Themes we foresee for the year and decade ahead
 

While some investors may have lost some faith in the emerging markets, we foresee a number of trends that we think will help turn around the fortunes of select emerging markets and reward investors who are careful stock pickers in these regions.
 

  • China’s growth rate will likely stabilize.

    We think private investment will recover and there will be greater geopolitical confidence along with cautious policy stimulus. We expect the shift towards consumption and private investment in the country will be propelled further by greater social spending in areas such as pensions and health care.
     
  • We expect economic growth across EM will slowly recover.

    We believe a weaker US dollar and low interest rates globally will allow EM countries’ central banks to be more aggressive with monetary easing. With a lower cost of capital, private sector investment will also likely recover. We expect the global manufacturing recession will reverse. In our view, credit markets in countries outside of China will also recover from their current abnormally low levels.
     
  • We believe EM equities markets will outperform the US stock market over the next decade.

    For many of the same reasons stated above – the prospect of a weak US dollar and low global interest  rates — we think the EM equities markets, which are already relatively inexpensive, will recover in the years ahead and potentially outperform the US stock market.
     
  • We expect a mean reversion in returns that will bring a market shift toward value
     

    We foresee substantial opportunities for outsized returns in neglected EM value stocks, as shown by the bifurcation of performance between high-quality growth stocks and everything else from a bottom-up perspective.
     

Justin Leverenz is a Team Leader and Senior Portfolio Manager for the OFI Emerging Markets Equity team at Invesco.

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