Emerging markets equities ended a tumultuous year on a positive note, with the MSCI EM Index up 18.4% in US dollar terms. It was a near-perfect reversal of 2018’s dismal 14.6% decline. Over the course of the year, however, the asset class provided a faithful mirror of global uncertainty on trade, economic growth, and geopolitics. After strong performance (+10.6%) in the first half of the year, emerging markets equities had a difficult third quarter (-4.3%) and rallied in the fourth quarter (+11.8%).
Trade was the biggest driver of emerging markets equities’ performance. The third quarter slump, for example, occurred as the United States levied an additional 10% tariff on US$300 billion worth of Chinese imports, labeled China a currency manipulator, and threatened to de-list Chinese companies from American exchanges. The strong rally in the fourth quarter came after two major trade developments. First, the US reduced existing tariffs on Chinese goods and cancelled additional planned tariffs as part of the Phase 1 trade deal. Second, the US reached a rare bipartisan agreement on terms for a trade deal among the US, Mexico, and Canada.
Solid growth in the US, buoyed by strong labor markets, supported global growth and contributed to the positive performance in emerging markets. But any hint of a slowdown rattled the export-dependent developing world, as demonstrated by mid-year moves in the US Treasury yield curve. The difference between yields on 10-year and 2-year Treasury bonds began to fall in late July and inverted for a few days in late August. An inverted curve is a well-known historical predictor of recessions, and the MSCI Emerging Markets index followed the yield differential down as the curve flattened. When the curve turned negative on 26 August, the index touched its lowest point since the beginning of the year.
Finally, geopolitical risk surfaced in many places. Large-scale protests emerged in Hong Kong, Lebanon, and multiple Latin American countries, while Alberto Fernández upset market-friendly Mauricio Macri’s bid for re-election in Argentina. (The election news was more anticipated, and more palatable to market participants, in Indonesia, India, and South Africa, where leaders seen as pro-market reformers were re-elected.) Democrats in the US House of Representatives launched an impeachment inquiry against US President Donald Trump, and terrorists attacked Saudi Arabia’s oil infrastructure. Oil production in the rest of the world easily filled the gap when Saudi supplies briefly went offline, and prices remained weak due to fears concerning excess supply and global growth. And while oil prices increased following the US strike against Iran’s General Qassem Soleimani, many investors are wondering whether excess oil supply concerns will temper those gains.
Looking ahead to 2020, trade tensions are likely to continue to influence the path of emerging markets equities, despite the long-awaited Phase 1 deal between the US and China. Market participants will also be watching the US Presidential election closely for hints about what might be in store for the US economy.
Those stories have been well-reported, but what gets less attention are the myriad forces working in favor of emerging markets equities. The gap between rates of economic growth in developed and emerging markets is likely to widen in favor of emerging markets in 2020. The two growth rates had been moving closer together in recent years, but emerging markets could easily start to pull away as the effects of US tax cuts in 2017 continue to fade. Meanwhile, stimulus measures in China, the largest emerging market economy, are likely to continue to bear fruit next year, particularly if a trade deal is in the books.
Monetary policy is also likely to remain accommodative in developed and emerging economies (Exhibit 1). Both the Federal Reserve and European Central Bank (ECB) eased in 2019, creating room for central banks to follow suit in a diverse array of emerging market economies, including Brazil, Mexico, the Philippines, Russia, and Turkey. The Fed’s easing, in particular, will likely help to keep the US dollar at bay, removing a major hurdle that plagued emerging markets equities in 2018.
Exhibit 1: The World’s Central Banks Are in Easing Mode
As of 30 December 2019
Source: Federal Reserve Bank of Dallas, Haver Analytics
As of 30 December 2019
Finally, there are the assets themselves. Though stocks rallied at the end of the year, valuations appear reasonably attractive, and consensus forecasts predict a return to positive earnings growth.
Emerging markets fundamentals point to an asset class that appears poised for solid growth in the coming year, but fundamentals have taken a backseat to global issues of late. If someone were to list the ideal conditions for emerging markets equities in 2020, they would include Goldilocks growth in the United States, steady global growth, continued central bank easing, and perhaps most importantly, a more concrete settlement to the trade issues hanging over the US and China. How those global issues evolve and how investors weigh macro forces versus stock fundamentals in 2020 remains to be seen.
The preceding is an excerpt from our Outlook on Emerging Markets. Read the full paper.
Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries.
An investment in bonds carries risk. If interest rates rise, bond prices usually decline. The longer a bond’s maturity, the greater the impact a change in interest rates can have on its price. If you do not hold a bond until maturity, you may experience a gain or loss when you sell. Bonds also carry the risk of default, which is the risk that the issuer is unable to make further income and principal payments. Other risks, including inflation risk, call risk, and pre-payment risk, also apply. High yield securities (also referred to as "junk bonds”) inherently have a higher degree of market risk, default risk, and credit risk. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries. Derivatives transactions, including those entered into for hedging purposes, may reduce returns or increase volatility, perhaps substantially. Forward currency contracts, and other derivatives investments are subject to the risk of default by the counterparty, can be illiquid and are subject to many of the risks of, and can be highly sensitive to changes in the value of, the related currency or other reference asset. As such, a small investment could have a potentially large impact on performance. Use of derivatives transactions, even if entered into for hedging purposes, may cause losses greater than if an account had not engaged in such transactions.
The performance quoted represents past performance. Past performance does not guarantee future results.
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The MSCI Emerging Markets Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The MSCI Emerging Markets Index consists of 26 emerging markets country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates. The index is unmanaged and has no fees. One cannot invest directly in an index.
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