The beginning of the end of cheap money was heralded as the time when emerging market stocks would reverse a decade past in the shadow of their developed country peers.
It is turning out to be the opposite.
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After a three-week rally in October that briefly raised hopes for a comeback, the benchmark for the group sank, hitting a 20-year low relative to its main US counterpart. That provides preliminary evidence that while global markets are adjusting to the idea of less stimulus from central banks, including the Federal Reserve, emerging markets are not getting much traction.
It is a family story. Despite faster growth and cheaper valuations, developing country equities have lagged the United States for most of the past 11 years. But, as the Fed’s gradual downsizing 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 “lost decade” of emerging markets appears only to be spreading.
“US stocks got more flow than emerging market stocks because fundamentally they are a better story,” said Daniel Gerard, senior multi-asset strategist at State Street Global Markets in Boston. Investors this week will see reports on economic activity from China to Russia and Brazil add to that narrative.
The MSCI Emerging Markets Index is down about 2% this year, compared to a 25% rally in the S&P 500 Index. That has pushed the ratio between the two indicators to the lowest since December 2001. While stocks of developing nations are 40% cheaper than their US peers, a poorer earnings outlook is discouraging investors from buying that discount.
“We remain cautious about emerging market stocks and prefer to be overweight in developed markets,” said Patrik Schowitz, global multi-asset strategist at JPMorgan Asset Management in Hong Kong. The performance headwinds have “added to much weaker earnings delivery in emerging markets than in developed markets.”
Since October 2010, the S&P 500 has soared nearly 300%, while the emerging markets gauge has added a paltry 14%. The latter also lagged behind Europe and Japan during this period. The market value of US stocks has risen by $ 39 trillion, while all designated emerging markets combined added less than $ 16 trillion.
Tighter monetary conditions may still lead to further capital flight from the US, where positioning has been very long for years. Yet emerging markets remain too weak to capitalize on that gap as their relative growth advantage shrinks, investors say.
Emerging economies expanded an average of 2.4 percentage points faster than developed countries in the six years prior to Covid-19. That spread has narrowed to about 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 is not expected to widen again before 2023.
At the center of all this is China, which accounts for 42% of emerging markets by market capitalization. Debt deleveraging and regulatory crackdown threaten to turn the growth trend in the world’s second-largest economy below 6% per year. President Xi Jinping’s “common prosperity” program also has the effect of returning the country to the communist principles of yesteryear.
Analysts are becoming skeptical of corporate performance in the developing world. Estimates of 12-month average earnings for members of the MSCI index stalled in the second half, while they rose around 7.5% for the S&P 500.
These are the events and the data to take into account this week:
- The leaders of the Communist Party of China gather for a crucial political meeting Monday through Thursday, in which President Xi Jinping could lay the groundwork to extend his term as leader.
- Wednesday’s inflation data will likely show another rise in factory prices to a new 26-year high and a rebound in costs for consumers.
- China’s export growth beat expectations in October as foreign demand for its products continued to rise, despite global supply chain disruptions, weekend data showed.
- Mexico’s central bank will likely raise the benchmark rate on Thursday, and Tuesday’s data will show that inflation continued to accelerate in October.
- Policymakers in Peru are also poised to increase borrowing costs on Thursday as inflation expectations rise.
- Thailand’s central bank is likely to keep its benchmark rate unchanged on Wednesday.
- South African Finance Minister Enoch Godongwana will present his first medium-term budget on Thursday. A windfall of income from rising commodity prices and changes in the way GDP is calculated is likely to lead to an improvement in key fiscal metrics.
© 2021 Bloomberg