The beginning of the end of cheap money was heralded as the moment emerging-market stocks would reverse a decade spent in the shadow of their developed-nation peers.
It’s turning out to be anything but.
After a three-week rally in October that briefly raised hopes of a comeback, the benchmark gauge for the group has sunk back, reaching a 20-year low relative to its main US counterpart. That’s providing early evidence that while global markets are adjusting to the idea of less stimulus from central banks including the Federal Reserve, emerging markets are failing to get much traction.
It’s a familiar story. Despite faster growth and cheaper valuations, developing-nation equities have trailed the US for most of the past 11 years. But, as Fed tapering loomed, money managers including Goldman Sachs Group Inc and Bank of America Corp saw a new commodity cycle and corporate growth ushering in an era of primacy for them. Instead, what some investors have described as the emerging-market “lost decade” only seems to be extending.
“US stocks received more flow than emerging-market stocks because fundamentally they are a better story,” said Daniel Gerard, a senior multi-asset strategist at State Street Global Markets in Boston. Investors will this week see how reports on economic activity from China to Russia and Brazil add to that narrative.
Fundamental flaw
The MSCI Emerging Markets Index has dropped about 2% this year, compared with a 25% rally in the S&P 500 Index. That’s driven the ratio between the two gauges to the lowest since December 2001. While developing-nations stocks are 40% cheaper than their US peers, a poorer earnings outlook is discouraging investors from buying into that discount.
“We remain cautious on emerging-market equities and prefer to be overweight across developed markets,” said Patrik Schowitz, a global multi-asset strategist at JPMorgan Asset Management in Hong Kong. Performance headwinds have “added up to much weaker earnings delivery in emerging markets than in developed markets.”
Since October 2010, the S&P 500 has soared almost 300% while the emerging-market gauge has added a paltry 14%. The latter also trailed behind Europe and Japan during this period. The market value of US stocks has surged by $39 trillion, while all the designated emerging markets combined added less than $16 trillion.
Tighter monetary conditions may still spark larger capital flight from the US, where positioning has been ultra-long for years. Yet, emerging markets remain too weak to capitalise on that vacuum as their relative growth advantage shrinks, investors say.
Emerging economies expanded an average 2.4 percentage points faster than developed countries in the six years before Covid-19. That differential has shrunk to an estimated 1.2 percentage points this year as developing nations fail to match richer countries in providing fiscal and monetary support to their economies. The spread isn’t expected to widen again before 2023.
Central to all this is China, which accounts for 42% of emerging markets by stock capitalisation. Debt deleveraging and a regulatory clampdown are threatening to shift trend growth in the world’s second-biggest economy to below 6% a year. President Xi Jinping’s “common prosperity” program also has the effect of taking the country back to communist principles of yore.
Analysts are turning skeptical on corporate performance in the developing world. Average 12-month profit estimates for the members of the MSCI index have stagnated in the second half, while they have increased about 7.5% for the S&P 500.