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Emerging markets offer great promise, but they also have a tendency to disappoint: Their net return over the past year was 12.4%, half that of the broader market as measured by the MSCI All Country World Index. Ten years ago, their annualized return was 2.7%, one-third that of the MSCI ACWI.
Globally, bad years tend to be particularly bad in developing countries, and the good years of the past decade or so have been even worse in developing countries. These markets are inherently volatile and subject to global policy decisions and capital flows.
That means a stronger dollar means U.S. and European investors don’t have to look far for yields. Inflows fall, making imported goods and services more expensive. The IMF calculates that a 10 percent stronger dollar would reduce emerging market economic output by 1.9 percent after one year, and continue to weigh on it for several years.
Another rift comes from the dismantling of globalization, the dismantling of supply chains across Asia and Latin America, and the reining in of trade. The mood in Washington, with the ban on certain technology exports to China and the recent tariffs on electric cars imposed by China, suggests little will change on this front.
Trade in goods fell 3 percent to $31 trillion last year, according to the United Nations, and 5 percent in goods. China has lost its top position as the world’s top goods exporter in some places, including to Mexico in the United States and to Germany in the United States.
Country-specific circumstances could blunt the results, especially if the country in question is China, which accounts for about a quarter of the MSCI EM index. China’s grand growth story has always relied heavily on investment and real estate, but it came undone in 2021 as the property market came to a screeching halt.
Investors, already spooked by the Chinese government’s high-profile attacks on the tech sector, have fled, with MSCI’s China index now at roughly half its 2021 high.
But China rolled out a (small) rescue package for its real estate market last month, interest rate cuts are on the way in the U.S. and Europe, and emerging market earnings are on track to rise 18% this year and 15% next.
Panglossians even discount more fundamental changes, such as restructuring supply chains. Reshoring is not just about US factories. Benefits from production-linked incentives include Asian countries like Vietnam, Malaysia and India. For China itself, the flip side of being left out is greater self-sufficiency.
Another encouraging sign is that AI is spreading to chipmakers. Taiwan’s TSMC is the world’s largest. Together with South Korea’s Samsung and SK Hynix, the trio make up 14% of the MSCI Emerging Markets Index. Tencent, the second-largest component after TSMC, is also doing well. The Chinese social media giant unveiled a large-scale language model last September.
Many elections have already concluded, including India’s largest, removing one element of uncertainty, but Americans’ voting choices will also have a major impact on these countries.
Of course, emerging markets, by definition, always have potential. Indeed, when markets live up to expectations, as India did last year, investors tend to start grumbling about high valuations. Still, there are enough signs that it’s worth a fresh look for investors who aren’t afraid of risk.
