The appeal of Emerging Markets’ (EMs) equities lies in the fact that it offers investors exposure to multiple regions with diversified growth drivers and the opportunity to invest in globally leading businesses. The potential for strong returns and faster growth has drawn investors to this equity segment. That said, the past decade has seen this segment lose its shine to Developed Markets’ (DMs) equities for several reasons such as the threat to globalisation, a slowing Chinese economy and more recently COVID-19 and the Russia-Ukraine conflict.
After ending on a positive note in 2020 and even pipping DM equities, EM equities lost momentum from March 2021 after EM central banks began hiking rates, marking the end of an easing cycle which started in 2019. As inflationary pressures rose further, more EM central banks raised rates. In contrast, only very few DM central banks hiked rates and that too closer to the last quarter of 2021. This divergence in rate hiking cycles opened a “Rates Gap” and is one of the drivers behind EM equities’ underperformance versus DM equities in the second half of 2021.
This underperformance could reverse as the hiking cycle abates in the EMs and heats up in the DMs, especially the US. This year, the US Federal Reserve is expected to raise rates aggressively in its fight against a 40-year high in inflation. Majority of the EMs, however, are already in the mid to late cycle of rate hikes.
Meanwhile EM equities are at extremely attractive levels relative to DM counterparts; the EM/DM price-to-book ratio is one standard deviation below the 15-year average1. EMs are also expected to grow 3.3% in 20232, surpassing the growth of the developed economies. Eastspring’s Multi Asset team sees the current discount for EMs, relative to DMs, as a sign that things are likely to be bottoming for EMs.
Separately, Eastspring’s Global Emerging Market equity team highlights that the valuation dispersion within the EM universe is also at extremes. The gap between the expensive narrow segment of the market and the value end of the market had grown to levels not seen for 20 years. The potential for further upside in value stocks within EMs appears significant but warrants an active bottom-up stock selection approach.
“Rates gap” has driven EMs underperformance vs DMs
Sources: 1 Price to book ratio is based on trailing data of MSCI EM Index and MSCI AC World Index, Mar 2022 2 World Economic Forum. April 2022. Forecast is for the Emerging Markets and developing economies.
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