Is it “time for a fresh look” at emerging markets (EMs)? asks Russ Mould of AJ Bell. The investment category has underperformed developed markets (DMs) for over a decade, leaving it at a steep discount to the US-dominated DM index. EMs trade at a roughly 35% discount to developed markets, with their weight in the average global mutual fund declining from 13% in 2010 to just 5% today, says Tom Stevenson in The Telegraph. Now, with global interest rates falling, they could be due a revival. The two key ingredients will be “China and commodities”. Beijing’s recent stimulus plan has lifted sentiment: Chinese shares are the largest single component of the MSCI EM index, a widely used benchmark. As for commodities, while the short-term picture is weak, long-term structural growth in demand for green transition metals heralds a favourable wind for the likes of Chile and Indonesia.
There have been pockets of strength, says Jay Jeon of Research Affiliates. Aided by booming demand for artificial intelligence semiconductors, Taiwan has returned more than 20% a year over the past five years, with India returning 17% per annum over the same period. Still, both markets now have valuations “that appear to be stretched to extremes”. Investors should not bank on continued outsized returns. “We are setting up for a major correction in India within the next year. People are so euphoric,” Ajay Krishnan of equity manager Wasatch tells Craig Mellow in Barron’s. Mellow suggests that investors instead investigate other more niche parts of the EM sector. The UAE is enjoying a listings boom. Southeast Asian countries, meanwhile, are “well positioned for the continued shifting of global supply chains”.
Emerging market dynamism doesn’t mean returns
A key attraction of emerging economies is their greater dynamism and growth potential, says Derek Horstmeyer in The Wall Street Journal. Yet, over the past decade, of the seven fastest-growing economies only one (India) has seen positive annual equity returns. “China, the Philippines, Vietnam, Turkey, Indonesia and Malaysia all averaged negative returns.”
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
How can this be? One factor may be that investors become overexcited, pricing in even better growth than that which ultimately occurs. There is also evidence to suggest that strong economic growth in EMs is often accompanied by a weakening currency (which makes exports more competitive). While stocks soar in local currency terms, foreign investors thus lose out. China and India show that growth doesn’t necessarily bring gains, says Edward Chancellor on Breakingviews. Chinese GDP growth has comfortably outstripped India over the past 15 years, but India has delivered far better equity returns.
The key factor is capital scarcity. Investment funds are plentiful in China because of the country’s “vast domestic savings”. That has caused overinvestment in unprofitable ventures, such as property. India finds itself in the opposite position, with expensive capital forcing companies to be disciplined. Gillem Tulloch of GMT Research estimates that between 2014 and 2023, Indian corporate return on equity (ROE) averaged 10%-13%, while in China it fell from 10% to 6%. When a market becomes saturated with investors’ cash, high returns are unlikely to last.
This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
-
Pension warning: one in five don’t know how much is going into their pensionHow to check your pension contributions and why it matters
-
50,000 power of attorney applications rejected – how to avoid common mistakesA freedom of information request shows that thousands of lasting power of attorney (LPA) applications are rejected due to errors. We explain how to avoid mistakes and reveal tips to make the process as straightforward as possible
-
Investment trusts could benefit from more optimismGive yourself an edge with investment trusts. Finding winning stocks is no mean feat.
-
Why the MoneyWeek ETF portfolio won't need to changeOur long-running ETF strategy won’t be placing any bets yet about what Donald Trump will do in his new term
-
Oil sector off the boil: what happens now?Oil giants BP and Shell are starting to struggle amid a glut of black gold. And growth in demand looks likely to slow
-
Improved prospects for income investorsIncome investors are raking in dividends, but it's not from the FTSE 100
-
Is Brevan Howard Macro a good investment?Holding Brevan Howard, a world-leading vehicle through an investment trust, offers diversification on the cheap
-
How can China boost consumption?China's new policies may give consumption a cyclical boost, even if long-term gains require more serious reforms
-
What is the outlook for oil prices?Oil prices will be set by the face-off between Saudi Arabia and US shale producers. Could tail risks change the possible outcome?
-
A fairer deal for investment trustsNew rules on how investment trusts report costs should ditch the idea that investors only need to look at one number
