This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
In the 35 years to the end of 2022 the MSCI Emerging Markets outperformed all other major indices, with the exception of the US which delivered superior annualised returns with lower volatility. However, if we go back a decade and look at the 25 years ending at the close of 2012, emerging markets was the top performer. So what caused this reversal?
One of the factors was that US and emerging market valuations were close to being aligned on a forward price-to-earnings basis in 2012. The dollar had experienced around a 10 year period of decline, making it comparatively cheap. Loose monetary policy and rising profit margins for US listed companies, particularly among the FAANG stocks, also contributed to investors preferring US companies over emerging markets as time progressed after the financial crisis.
Today, the situation has reversed. The dollar is relatively expensive, equity valuations are still high in the US despite some declines, and we are in a rate-hiking cycle. Meanwhile, the cyclically adjusted P/E ratio for the MSCI Emerging Market Index is 10.3, compared to 23.3 for the US. So essentially we’re in the opposite position to where we were approximately a decade ago.
We’ve seen see-sawing like this before. Emerging markets performed relatively well in the 1970s, for example, whereas the US was hit with high inflation and poor equity returns. Then the 1980s saw a reversal of that trend, most notably with the Reagan boom in the US but a debt crisis in Latin America.
Whether or not things will play out the same as before is hard to say. For instance, a lot of emerging market growth was predicated on globalisation, with developed nations eager to cut costs by outsourcing to cheaper markets. The drive to ‘onshore’ may mean that is no longer in play.
However, Kepler’s own emerging markets team estimate that Vietnam, Indonesia and India all will see annual GDP growth of approximately 9% in dollar terms over the coming decade. Poland and the former Eastern Bloc countries are also forecast to see their per capita income grow to the same level as Southern European EU member states within the next 20 years.
We have already seen the potential this growth offers in country-specific funds, such as Vietnam Enterprise Investments (VEIL) and Ashoka India Equity (AIE), which have delivered annualised NAV total returns of over 13% since their IPOs.
For investors looking for broader exposure to emerging markets, Fidelity Emerging Markets (FEML) may also be an attractive option. The trust invests across emerging markets and seeks to deliver long-term returns with lower risk. It is also unique in the sector as managers Nick Price and Chris Tennant can take short positions and invest across the market cap spectrum.
While volatility is likely to remain pronounced in emerging markets, those willing to hold for the long-term may see 2022 as an attractive entry point, just as we do when looking back at US performance in the wake of the financial crisis. Market cycles exist, and it is plausible that the US may not deliver the same strong returns it has over the past decade, whereas emerging markets could enjoy a resurgence.
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