2020 may have been a turning point for emerging market assets. At least, all the traditional indicators supporting emerging markets have turned positive: the USD is trending down; commodities are trending up; USD liquidity is abundant; and tolerance for risk is high. Also, emerging markets stocks have started to outperform and ended the year almost even with the S&P 500. Though these trends tend to last, we will need confirmation over the next six months. Still, these conditions are enough to be bullish emerging markets and be fully loaded in terms of portfolio allocation.
The year of the great pandemic will probably be seen as pivotal in that it accelerated existing trends and starkly highlighted strengths and weaknesses. Good governance was demonstrated by how countries dealt with Covid both in terms of public health policy and fiscal response. It turned out that those countries least able to control Covid were also those most inclined to monetize initiatives to support consumption through fiscal handouts. In many cases (e.g. the U.S., Brazil) these were also countries with weak fiscal positions before the pandemic, and therefore much worse positions by the end of the year. Moreover, those countries that dealt correctly with Covid (almost all in Asia) also represent the manufacturing base of the world, so that money printing to support consumption in developed countries went to Asian exporters. The charts below show total annual returns for the past year and past ten years (MSCI). What we see is that 2020 simply accentuated the trends of the past decade. It was a year when Asia showed all of its strengths (good governance, fiscal probity, commitment to value-added manufacturing, managed currencies) and most of the rest of emerging markets were characterized by dysfunctional politics, incoherent and inconsistent economic policies, and fiscal profligacy.
We show below the returns for the major MSCI EM regions for 1yr,3yr,5yr and 10yr to point out the consistency over time.
We see a similar pattern in terms of currencies in the following charts. Asian economies have been able to maintain their currencies stable and at competitive levels, while most other EM currencies lose value over time and are extremely volatile. Of course, Asian manufacturing benefits greatly from this while manufacturers in countries like Brazil are at a huge disadvantage.
Undoubtedly, Asian stock prices have benefited from exposure to growth sectors, especially technology. Almost 90% of the EM tech sector is based in Asia, with 70% in China alone. As shown below, growth has underperformed in emerging markets, as it has in other regions, because of the scarcity of growth companies in a stagnant global economy and low interest rates. On the other hand, value has performed poorly (Total returns, annualized).
Of course, past performance is not necessarily indicative of the future. Value is now relatively cheap and, due to its cyclical nature, tends to do well when EM does well. This means that, in spite of secular trends that favor Asia, the rest of EM may actually perform well in a reflationary cyclical emerging market rally. By the way, this would catch by surprise almost all EM actively managed funds that are now largely proxies for Asian tech.