Emerging market stocks bounce as investors pour in

As “the old joke” has it, “an emerging market is one from which investors cannot emerge unscathed when things go wrong”, says Russ Mould of AJ Bell. Yet with commodity prices rallying and talk everywhere of a global upswing, today investors are more interested in what can go right.

Two-thirds of fund managers surveyed by Bank of America think emerging markets will be the best-performing major asset class this year, notes Jonathan Wheatley in the Financial Times. Around $17bn of overseas cash poured into 30 major developing countries during the first three weeks of January alone. Global investors had already ploughed nearly $180bn into emerging market stocks and bonds during the final quarter of last year. The MSCI Emerging Markets (EM) index has returned 83.7% since 23 March last year.

A structural growth story

Long the preserve of stodgy commodity exporters and metal bashers, today developing markets are no longer simply geared plays on the global growth cycle. There is plenty of structural growth potential too, with an increasingly dynamic tech scene. By next year “three times as many internet users will live in emerging markets” as in developed ones, says Mark Atherton in The Times. Investors in this category could do with a break. The MSCI EM index has returned 49% over the past decade, far short of the 156% gain on the equivalent developed-market index. The EM index finally regained its 2007 all-time high last month.

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On a longer view, emerging markets still beat the MSCI World index, says Ben Johnson on Morningstar.com. For all their “gut wrenching volatility” and prolonged slumps, since 2001 the EM index has returned an annualised 9.59% compared to 6.02% for developed markets.

These days emerging and developed markets are moving in increasingly tight lockstep anyway. That is not a good thing – global investors want diversification, not pale imitations of what happens on Wall Street. Policy announcements by the Federal Reserve can dictate trading movements from Sao Paulo to Mumbai. The key culprit appears to be the US dollar, which is widely thought to be heading lower.

As Graham Smith points out on fidelity.co.uk, a weaker dollar acts like a monetary stimulus for businesses in emerging economies, which often borrow in greenbacks. It also incentivises investment inflows from foreign buyers looking to diversify their currency exposure.

On around 15 times 2021 earnings, emerging markets are not especially cheap compared to their own history, but they offer better value than richly priced developed markets. After such prolonged gloom, investors think 2021 could prove “the year for emerging markets”.