Submitted by Nicholas Colas of DataTrek Research
There used to be a fatalistic Wall Street witticism about emerging markets that went like this: “Brazil/Russia/Argentina/whatever is the economy of the future, and it always will be”. You heard it most often during the marketing of a big privatization IPO, albeit in whispered tones. The saying invariably proved true, but a few months later there would be the same joke with a different country’s name appended to the start. And a new privatization to market. Lather, rinse, repeat.
If you take a moment to pull up a long-term chart of the MSCI Emerging Markets Index (use EEM if you like, the longest lived ETF in the space), you’ll see a pattern that broadly comports with that aphorism. Specifically:
- The all time high for EM equities on a monthly basis was over a decade ago, in October 2007.
- The S&P 500, tied to a slower US economy than EM, is up 83% on a price basis since its prior-cycle highs in the same month of 2007.
- EM equities are actually 25% lower than their October 2008 highs, or a 108 percentage point underperformance versus US equities. Put another way, you would have doubled your money long the S&P 500 and short EM since the prior top, and been nicely hedged during the Financial Crisis to boot.
- EM equities have essentially done nothing the entire decade of the 2010s, unchanged from their August 2010 levels at today’s close.
All this forces an important question: why does anyone own these things? We will confess to an EM allocation in our own IRA, so we’re not throwing stones here. But the numbers don’t lie. And they are not pretty.
You can’t blame this parlous performance entirely on sector allocation or stock performance either. Technology is a chunkier part of the MSCI EM Index than even the S&P 500, at a 27% weighting currently versus 26%. And the heavyweight names in the EM index – Tencent, Taiwan Semi, Alibaba, Baidu – all have good 5-year performance numbers. It’s the rest of the players that have let down the team.
Go back to that long-term MSCI EM stock chart and you’ll see when the asset class actually does work, at least since the Financial Crisis. The first time was off the 2009 bottom, when it doubled in 2 years. The second time was from the start of 2016 to January 2018, when it rose by just over 60%. Everything else was just treading water.
That leaves us with the conclusion that EM equities are trades more than investments, if you grant us the liberty to call a 1-2 year holding period a “trade”. They work when the global economy is either recovering from a crisis (2009 to 2011) or set to accelerate (2016 – early 2018). Otherwise, they can be frustrating “economy of the future” investments.
That means the reason to overweight EM equities right here boils down to one question: is the “Crisis” of trade/tariff tensions going to abate soon? While those have clearly helped US equities, pulling capital onshore to gain exposure to a strong domestic economy, they have dinged EM equities by roughly twice as much as they have lifted the S&P 500.
Recent money flow data shows investors do not yet have much confidence in a positive resolution to this question. EM equity ETF flows have ground to a halt over the last 5 days after seeing $2.3 billion of inflows the prior 3 weeks. It seems investors have finally moved to the sidelines until a lasting resolution is more obvious. Thrice bitten, once shy.
Bottom line: we take the current administration at their word that trade is an important part of their agenda so we aren’t expecting any relief soon for EM equities. So is performing well during midterm elections, however, so we do expect some movement on the trade front in the next few months. Markets will slowly discount that, but cautiously so. It’s going to be a slow grind, at best, for EM equities