A Brighter Future for Emerging-Market Stocks
March 02, 2017
Emerging markets have recovered their footing, and we expect continued good performance in the period ahead. While there are certainly risks to be mindful of, we believe these risks are manageable if investors position themselves to navigate the volatility inherent to the asset class. Read below, or listen to the podcast.
Between 2011 and 2015, emerging markets were buffeted by a perfect storm of low commodity prices, weak global trade, overcapacity in a number of industries, and reduced profit margins. Consequently, the MSCI Emerging Markets (EM) Index fell nearly 22% over those five years, in US dollar terms. It also massively underperformed the MSCI All Country World Index (ACWI), which includes developed and emerging-market stocks, as the left side of the Display below shows.
But in 2016 and the first two months of 2017, the EM Index regained much of its lost ground and outperformed the ACWI, as several of these negatives have reversed: Commodity prices have stabilized and, in some cases, increased; global trade is growing again; and China has taken steps to reduce industry overcapacity.
We don’t believe we’re seeing a return to the golden years of 2003 to 2007, when strong global trade and earnings growth in emerging markets boosted EM Index returns. But valuations are now cheap, and expectations are low—a combination that bodes well for the asset class’s future returns. Of course, there are risks to consider as well.
The potential impact of the Trump administration’s trade policies is one risk that tempers our optimism. Trade barriers or tariffs would be negative for emerging markets overall, and particularly for Asia, but the impact would vary by sector.
We expect US trade policy to focus on industries that still employ many people in the US, such as auto and steel. Technology and other sectors with few remaining US employees are likely to be affected less, because it will be difficult to bring those jobs back to the US, in part due to the complexity of supply chains that often include many companies supplying different components.
US Dollar Appreciation
A strong US dollar has typically been negative for emerging markets, because it tends to attract flows into the US and away from emerging markets and other, riskier asset classes. We’re not too worried about the dollar today. The dollar has strengthened nearly 30% in the last five years; we don’t see dramatic strengthening from here.
China’s protracted slowdown is a concern, especially given its size. But despite significant volatility along the way, the Chinese stock market has outperformed global developed markets over the past 10 years. While we are well aware of China’s current risks, we’re less negative on China than many investors, for several reasons.
First, consumption growth in China has been steady, and we see a number of Chinese companies with strong growth potential. Second, government reforms are tackling overcapacity in old, industrial sectors, which is restoring profitability for those sectors in China and elsewhere. Third, the government has a strong incentive to preserve stability as it heads to the party meeting at which President Xi will announce his leadership group for the next five years; we believe it will be able to deliver that stability in the near term.
Managing Through the Recovery
These risks are manageable, in our view, but emerging markets do tend to be more volatile than developed markets. There are three ways that investors can mitigate the impact of that volatility on their portfolios:
• Buy companies, rather than countries. That can shield investors from market volatility in response to broad economic trends for a country that may not affect all companies domiciled there.
• Diversify across countries and sectors. Today, we own both commodity importers and exporters, and both domestic and international companies.
• Pay close attention to each company’s downside risks. We often speak to others who are bearish on a stock to understand what could go wrong; then, we monitor those issues.
These steps won’t shield investors from all the ups and downs in emerging markets, but we believe that in concert they can mitigate the impact, and help investors stay in the asset class to participate in the continued recovery that we foresee.
The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices, any securities, or financial products. This report is not approved, reviewed, or produced by MSCI.