While prospects at the start of 2016 seemed rather dour for emerging markets, resilience has been the story in the asset class for the first half of the year. What’s behind the improvement in emerging-market equities? Here are some general themes I will briefly touch on:
- Growth in emerging markets continues to outpace that of developed markets
- Improved investor sentiment and attractive valuations have helped drive asset flows
- China’s market/economy hasn’t imploded as many had feared at the start of the year
- Political, economic and structural changes have been taking place in many markets
Year-to-date, emerging-market equities have outperformed developed markets in US dollar terms, with the MSCI Emerging Markets Index up 14.5%, while the MSCI World Index is up 2.7%.1 Growth rates in emerging markets also continue to outpace those of developed markets; the International Monetary Fund estimates gross domestic product growth of 1.8% in 2016 and 2017 for advanced economies, and growth of 4.1% and 4.6%, respectively, in emerging/developing economies.2 In August, Moody’s ratings agency revised its outlook on the world’s largest emerging-market economies upward for 2016 and 2017, with the expectation that these economies have stabilized.3
While the year is not yet over, we see brighter prospects for investors in emerging markets compared with last year, and the long-term performance of emerging-market equities compares favorably to that of developed markets.
The asset class received strong inflows this summer as investors continued to search for higher yields, helping to drive outperformance.4 A rebound in commodity prices this year led by oil has further shifted investor sentiment in favor of emerging-market equities. At the same time, many emerging-market countries have moved to lessen their dependence on commodities as drivers of growth and have diversified their economies into other areas, including information technology and other service-based sectors.
The US dollar has stabilized, and this has largely benefited emerging markets as it reduces the threat of a US dollar-denominated debt; many companies in emerging markets have issued debt in US dollars, making it harder to repay when their economies are weak at the same time the US dollar is very strong. In addition, given challenges surrounding the global economy, including the United Kingdom’s referendum vote to leave the European Union, several major central banks have taken a dovish stance on interest rates, which we think bodes positively for emerging markets’ growth and assets. At the same time, the US Federal Reserve (Fed) has been very cautious in terms of tightening this year. We think emerging markets should be able to weather small and gradual increases in US interest rates, which seems to be the path Fed policymakers have indicated.
In addition, many emerging-market countries are making meaningful progress on structural reforms to stimulate growth and their respective share markets. For example, India recently passed a national bankruptcy law, and a goods-and-services tax (GST) bill, and has relaxed foreign direct investment rules to further stimulate economic growth.