Investors eye emerging market upswing after China shock

Some see EM pain as overdone after ‘lost decade’ compared with US and European equities.

  • By Robin Wigglesworth,
  • Financial Times
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The renewed struggles of emerging markets caused by the recent wobble in Chinese equities has led some investors and analysts to spot an enticing opportunity to bet that a decade of pain may soon be over. 

Emerging stock markets such as Brazil, India, Turkey or South Africa have trailed significantly behind developed markets for much of the past decade, especially compared with runaway US equities. 

Blue-chip US stocks have had total returns of 356 per cent over the past 10 years, thumping the 188 per cent return of European equities over the same period, according to Refinitiv data. But emerging markets have done even worse, with the MSCI EM index (.MXEF) returning only 66 per cent, leading some analysts to describe it as a “lost decade” for emerging markets. 

After starting 2021 on a bright note as investors bet on a global economic renaissance and commodity prices rushed higher, EM equities were thrown back into reverse by China’s regulatory clampdown on industries from financial technology to education. As a result, the MSCI EM index has slipped another 1.4 per cent this year, even as most other markets have soared.

However, some investors and analysts think a resilient global economic upswing, buoyant demand for many natural resources and stretched valuations elsewhere could help emerging markets recover their vim. 

“There are pockets of opportunities now,” said Peter Oppenheimer, chief global equity strategist at Goldman Sachs. “Given how emerging markets have derated, if concerns about the Delta variant moderate a little bit and we don’t get more significant anti-market interventions in China, I think there will be a reasonable rebound.”

Despite the muddled performance of emerging markets, EM equity funds have taken in $81bn already this year, according to flow data provider EPFR. If sustained this would constitute the strongest year for investor inflows since 2010 and the second strongest since at least 2000. 

Eric Robertsen, global head of research and chief strategist at Standard Chartered Bank, estimates that EM stocks now trade at a discount of about 40 per cent to US equities owing to worries about the global economic recovery caused by the Delta variant of Covid-19 and the Chinese crackdown. 

“We believe this growth pessimism is overdone and that EM assets look attractive. The timing might still be premature, but we are looking for that entry point,” he said in a note.

Some investors and analysts are also betting that emerging bond markets will start to do better. Although EM bonds have over the past two centuries tended in the long run to outperform other fixed income markets despite periodic developing country debt crises, they have only returned about 60 per cent over the past decade, lagging behind the returns of US investment grade and junk bonds.

EM sovereign bonds denominated in the country’s own currency have actually lost money over the past decade, according to a widely-followed exchange traded fund, as slower growth, listless commodity prices and other headwinds have depressed their exchange rates. EM bonds — both local currency and dollar denominated securities — have remained weak in 2021.

Nuveen, the $1tn US asset manager, is among the investment groups now eyeing an EM resurgence, especially in Latin American government bonds and Asian equities, which it reckons should benefit from a broadening global economic recovery and mounting inflationary pressures. 

“As we enter a period of rising rates and increasing inflation, endowments and foundations will need to look elsewhere for exposures that have a better chance of outpacing inflation while also providing diversification from equities,” Nathan Shetty, head of multi-assets at Nuveen, said in a recent report. 

Many analysts and fund managers remain sceptical about emerging markets, however, with Chinese risks looming large at the moment. China accounts for more than a third of MSCI and FTSE Russell’s influential flagship EM indices and the country’s economic heft is so great that its ebbs and flows can affect sentiment to the developing world more widely. 

Beijing’s crackdown has sent the Hong Kong stock market down more than 10 per cent since the beginning of July and the onshore CSI 300 index has slipped 6.4 per cent. Oppenheimer said some global investors now consider Chinese equities to be “uninvestable”, given fears that more measures are coming. 

Analysts at JPMorgan point out that the availability of vaccines in the developed world has also helped economies reopen quicker and more fully than in many emerging markets. This will almost eliminate the longstanding growth gap between poorer but faster-expanding emerging economies and the now-booming rich world, they reckon. 

Despite being optimistic for emerging markets to recover their footing in the near term, Oppenheimer also points out some challenges confronting them in the longer term, such as slowing globalisation and mounting pressures for investors to take environmental, social and governance factors into account, as issues that EM often scores badly on. 

“Are we going into a golden era where emerging markets massively outperforms? I think that is less clear,” he said. “I think that there are some structural headwinds compared to what emerging markets faced in the past 20 years.”

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