Emerging Markets stocks have traditionally been an asset class closely tied to the global economic cycle. When the global economy was strong relative to the U.S. economy, the dollar would depreciate, commodity prices would rise and emerging markets would enjoy a period of ample liquidity and rising asset prices.
We can see this clearly in the chart below: since the 1980s, there have been two downcycles for the USD (1985-1997 and 2002-2012) which have coincided with bull markets in EM equities. We are now in the ninth year of a dollar upcycle, which has resulted in very poor returns for emerging markets investors.
It is not happenstance that emerging market stocks and “value” stocks are strongly correlated. The periods of strong performance for “value” (stocks with low prices relative to book value, earnings or sales compared to the overall market) have been largely concurrent with those for EM stocks, and the past ten years have been terrible for both. This is because both the value and EM universes are heavily weighted to cyclical and mature industries and sectors that are vulnerable to technological disruption. The chart below shows the performance of both the value and core indexes for U.S. and EM stocks for the past 10 years.
If we look at the performance data for EM in more detail we can see that regional disparaties are pronounced. The chart below highlight the enormous transformation that the asset class is undergoing, both in terms of the growing weight of China and Asia but also in terms of the surge of the technology sector. While 10-years ago the index was dominated by commodity producers, today almost every stock in the list is driven by the smart-phone/e.commerce revolution. Every single stock, except for Reliance of India operates in North Eastern Asia.
The charts below detail total annual returns by region and by style (value) year-to-date, 1-year, 5-years, and 10-years. A cursory glance at these numbers makes one thing clear: over the past ten years, in emerging markets it has always paid to be in Asia and out of value stocks.
The outperformance of Asia is explained by growing importance of the tech sector, both traditional players (TSMC, Samsung) and a plethora of newcomers in e.commerce. The lack of tech in Latin America can be seen in the poor performance relative to Asia and in the similar returns between the Latin America core index and its value index. Just like in the U.S., emerging markets are now driven by tech, as shown in the chart below.
Even within regions or countries, owning tech has been the correct strategy. Value has underperformed in every region. Within China, owning tech and avoiding value (state companies, banks) has been the trade.
In Indonesia, buying SEA Ltd, the country’s largest e.commerce company, has been the trade.
In Latin America, the one thing to do has been to buy Mercado Libre, the leading e.commerce site in Brazil and Argentina.
What the future will bring is anyone’s guess. Another downcycle for the USD is likely to start over the next several years, providing support for EM value stocks. On the other hand, low global growth and intensive technology disruption should continue to boost the valuations of scarce growth opportunities.
Very good analysis, Jean. Congrats.