By Sammy Suzuki, CFA | Head—Emerging Markets Equities; Co-Chief Investment Officer—Strategic Core Equities at AllianceBernstein.
For over a decade, emerging markets (EMs) have been full of promise—and disappointment. Year after year, investors have waited for the powerful growth trends of the past that drove developing markets from Mexico to Malaysia to reassert themselves.
But looking back to assess the future is a questionable strategy. Instead, we think investors should focus on the changing dynamics in EM economies and markets that could reignite returns in the years ahead. Capturing this potential requires specialized research skills because EM companies and markets still march to a different beat than their developed-market (DM) peers.
From Boom to Bust: Two Eras in 20 Years
It’s easy to understand why expectations of EM are anchored to the past. From 2001 to 2010, as historic change swept through the developing world, the MSCI Emerging Markets Index posted supercharged annualized returns of 15.9%, outpacing DM stocks by a wide margin. Yet since 2011, EM equities have advanced by a paltry 0.9% annualized.
The EM bull market of 2001-2010 was fueled by unique circumstances. China joined the World Trade Organization in 2001, increasing its share of world exports and accelerating globalization. As this played out, China made massive investments in fixed assets and real estate, unleashing a commodities super-cycle. From 2000-2010, China’s GDP grew by 10.6% on average, boosting global economic activity while enriching commodity-producing EM countries and supporting their currencies. Inside China, a wave of unbridled commercialism reshaped the business landscape in a colossal cultural shift that generated handsome payoffs for astute investors.
Since 2011, the EM tables have turned. Many EM economies suffered a hangover from the boom, caused by uncompetitive currencies and a failure to reform, particularly among commodity-exporting countries. Since 2014, the US dollar strengthened, eroding US-dollar earnings-per-share growth for EM companies. Commodity prices eased and geopolitical concerns intensified, from the US-China trade wars to Russia’s invasion of Ukraine, while the COVID-19 pandemic added new challenges.
Meanwhile, in China, annual GDP growth slowed to 6.6% from 2011-2022 and is expected to decelerate to about 4.5% in the coming years, according to consensus estimates. Under President Xi Jinping, who came to power in 2013, China began to pursue more assertive foreign policy and domestic economic reforms. More recently, China’s government has tempered support for entrepreneurialism in favor of a broader agenda focused on social equality. Against this backdrop, EM corporate earnings suffered a lost decade (Display), which suppressed equity returns.
What Will It Take to Unleash Return Potential?
EM companies should enjoy strong tailwinds for growth, in our view. Across the developing world, rising incomes, urbanization, and government policies aimed at promoting economic growth lead more people into higher-income employment. With more income, the middle class begins to spend on products and services that it couldn’t afford previously.
Domestic reforms, manufacturing growth through reshoring, and technological progress all support sustainable middle-class growth. And the socioeconomic forces that persuade people to pursue a better life are even more powerful today, in a world where easily accessible online information broadens the appeal of premium products and services.
Constraints on EM equity market performance may be starting to ease. Currency dynamics look favorable, China is reopening its economy after pandemic lockdowns, and EM growth is poised to widen the gap with DM growth after the differential narrowed in recent years.
In aggregate, developing economies are almost as large as DM economies, yet EM remains underrepresented in global equity indices. The time is right for investors to revisit their EM exposures within global equity allocations and build a long-term strategic plan that is designed to capture the next phase of the developing world’s growth evolution
