By definition, emerging markets are dynamic, having changed considerably over the past three decades, with the pace of change being only accelerated in recent years. Emerging markets are countries equipped with less-stable political and legal systems than developed markets, and are transitioning into industrial, modern economies often at a rapid pace. These markets are becoming more integrated with the global economy, illustrated by increased liquidity in local debt and equity markets, increased trade volume and foreign direct investment, and the domestic development of modern financial and regulatory institutions .
Usually the less risk-averse type of investor seeks out emerging markets for the prospect of high returns, given the faster economic growth (as measured by GDP) typically experienced by emerging markets. This comes however, at the price of greater risk. This risk often takes the form of political instability, currency volatility, and illiquid equity .
Whereas shares in the developed economies regained their 2007 peak as long ago as 2014, and have since risen by about 60%, MSCI’s Emerging Markets Index did not surpass its 2007 peak until January of this year, when it set a new record, thanks to a rally in recent months . Using the MSCI All Country World Investable Market Index, emerging markets stocks made up about 13% of the global stock market as of the end of 2020. In comparison, when the MSCI Emerging Markets Index was launched in 1988, these stocks represented less than 1% of the world’s investable equity market capitalisation .
The MSCI Emerging Markets Index is used to measure equity market performance in global emerging markets. The index captures mid and large caps in 27 countries including China, India, Korea, Mexico, Taiwan, and the United Arab Emirates . The index is most heavily weighted in China (40.13%) . Meanwhile, the MSCI All Country World Investable Market Index captures large and mid-cap representation across 23 developed markets and 27 emerging market countries with the heaviest weighting on the U.S. (57.07%) . Finally, the MSCI World Index involves just the 23 developed market economies .
Record highs for emerging markets in January
The fourth quarter of 2020 paved the way for the record highs experienced by emerging markets in early 2021. The MSCI Emerging Markets Index outperformed the MSCI World Index, in the last three months of 2020, with a return of 19.7% compared with 14.0% .
The emerging markets have sustained their outperformance against the developed world with the Financial Times reporting a 9% rise in the MSCI Emerging Markets Index in first three weeks of 2021 versus just 2.7% for its MSCI World Index counterpart .
In terms of stocks and bonds, emerging markets saw foreign net inflows of approximately $53.5 billion in January, building on the momentum from year-end 2020, according to data from the Institute of International Finance . Alongside this, non-resident portfolio inflows to emerging markets equities hit $9.4 billion in January and debt instruments attracted $44.2 billion, according to the IIF. It is the tenth consecutive month of net positive flows to emerging markets.
However, emerging markets stocks have seen a slight slump between the 25th and the 29th of January with the MSCI Emerging Markets Index closing at $1,329.57 (29th January), as a surge in COVID-19 cases and doubts over the rollout of vaccine programmes reduced risk appetite and boosted the U.S. dollar against most currencies , but has since rebounded to $1429.96 (as of the 12th of February).
What explains the bullish investor sentiment?
Investors have been buoyed by the better than expected performance of many developing economies during the pandemic and by the early arrival of vaccines. Despite severe mortality rates in some countries, especially in Latin America, many others have suffered less acutely than expected, putting less strain than feared on health services and stretched public finances .
Many investors hope emerging markets reliant on exports of commodities and other goods will benefit from rising demand from China, where the economy grew 2.3% last year as other large economies contracted, and from the U.S., where Joe Biden’s administration is expected to spend heavily on infrastructure and other productive investments and investors price in an anticipated more traditional foreign policy approach compared to the Trump administration.
Also helping the trend is investor’s appetite for undervalued assets while markets in the developed world, particularly the U.S., have remained elevated from inflationary pressures.
As Russ Mould, Investment Research Director at AJ Bell, said: “this apparent return to form for emerging markets coincides with a period of strength for commodity prices and dollar weakness. Whether it lasts may hinge to a great degree on those two trends, which also tie into the inflation narrative.” .
A further consideration supporting the emerging market investment case is that the asset class may be better positioned than developed markets for the pandemic recovery. So far, Korea and Taiwan have rebounded as global export activity began to recover in recent months. Looking ahead, there is hope that Hong Kong and Thailand will also benefit from a return to relative normality, as tourism and business travel recover in the medium-to-long-term .
However, the fall in the MSCI Emerging Markets Index at the end of January illustrates the high volatility existent within emerging markets. It has been attributed to the rising COVID-19 cases and concerns over the rollout of the vaccine across emerging markets which has dampened appetite for their assets, with investors also scrutinising high-stock valuations as economic trends showed little improvement .
Prospects moving forwards
Asset management firm, Lazard paints an optimistic picture for emerging markets for 2021, pointing to a bullish outlook for commodity prices and reduced uncertainty and tensions in global trade. They state that a rebound in demand as global growth recovers should support strong commodity prices coupled with tightened supply. Furthermore, as the Biden administration is already demonstrating a shift away protectionist policies, Lazard believes that this should bolster global trade, in turn increasing global growth, while reducing geopolitical uncertainty .
HSBC Global Head of Emerging Markets Research Murat Ulgen, and his team laid out a number of positives and setbacks facing emerging market assets in the year ahead. HSBC suggested that with the Fed having “opened a new chapter on monetary policy” and the European Central Bank increasing its asset purchases, there should be “ample liquidity” to support risk assets in 2021. Furthermore, Ulgen highlighted that a reduction in imports to emerging market countries during the pandemic means that their current account deficits have narrowed and he noted that while emerging markets valuations are fairly stretched, they remain more in check than those in developed markets .
However, the HSBC team also warned of several setbacks to the performance of emerging markets. This included the issues that may be encountered with vaccine rollouts, or the prospect of new restrictions which could pose a risk to emerging markets assets. Furthermore, an early rollback of the expansionary fiscal and monetary policy which has sustained markets over the past year may be detrimental. Finally, there is the risk of inflation .
Therefore, moving forwards, the ongoing fiscal and monetary stimulus from governments and global central banks may help to diminish the impact that emerging markets are facing from the pandemic, but whether this will be sustained, rests on the international community’s efforts to contain the virus as well as the performance of macroeconomic indicators in developed economies.
UCL undergraduate studying History, Politics and Economics.