A particular challenge is currently that sectors and countries that are sensitive to the effects on trade of COVID-19 related restrictions may lag as they did for much of 2018 and 2019, making them less appealing to investors. The alternative – taking refuge in domestic-oriented sectors – is also not an obvious option since the coronavirus pandemic has decimated domestic demand (see Exhibit 1).
As US stocks have led the rest of the developed world, so Asia has led EM stocks
One of the key dynamics over the last five years has been the outperformance of the Asian region versus EMEA and Latin America. It is actually China that has outperformed. The emerging markets Asia-ex China sub-group has only matched the performance of the rest of the index (see Exhibit 2), in many ways mirroring the outperformance of the US versus the MSCI World index.
As yet, China does not take up as dominant a share of the EM index as the US does for developed markets. China accounts for just 41% of the MSCI EM index, while the US alone makes up 65% of the market capitalisation of the MSCI World.
It is difficult to see the laggards catching up…
Although EMEA and Latin America have lagged since the global market bottom in March 2009, it is hard to imagine a sustained period of outperformance now. The near-term economic outlook is challenging due to the coronavirus pandemic and Latin America has suffered particularly.
Credit metrics in the region are far worse than in the rest of emerging markets. Its share of corporate debt in hard currency is above average. Foreign sales account for a relatively small share of total corporate revenue and current account deficits are high.
EMEA fares better from a credit perspective (with the notable exceptions of South Africa and Turkey). While foreign debt is also high, the currencies have held up better. Trade exposure to western Europe is an advantage and, at least in central and eastern Europe, the pandemic has been well managed generally.
Key advantage for Asia and China: The exposure to tech
Even more so than in developed markets, the technology sector has outperformed the rest of the market dramatically (see Exhibit 3). EM Asia has a far higher exposure to technology than the other regions, and China in particular has more ‘new’ technology companies (internet retail and interactive media) than South Korea or Taiwan.
Another positive factor for Asia relative to developed markets is that market valuations of technology stocks are nowhere near the levels of those in the US. Relative ratios are close to the low end of historical ranges.
While China is more highly valued than other emerging markets, both the price-book and price-earnings ratio z-scores are only slightly above average and are closer to the values of the other countries in the region if the tech sector is excluded.
The z-score for the price-book ratio for broad tech sector in China is 0.6 against 1.4 in the US. And not surprisingly, the improving outlook for tech sector earnings because of the pandemic translates into higher expected earnings growth for those countries and regions.
Rebounding commodity prices to benefit EM equities?
In the short term, the one factor that would play to the strengths of Latin America and EMEA would be a continued rebound in commodity prices. Although the GSCI Energy & Metals index has risen by nearly 70% from the lows in April, it is still nearer the troughs over the last 10 years than the average (see Exhibit 4).
Even with a gradual and bumpy rebound in global growth, and perhaps permanent reductions in travel (both for tourism and commuting), a further recovery seems likely. Both Latin America and EMEA have a higher share of energy, materials and utility sector stocks in their indices than in Asia, and the sensitivity of the indices to the GSCI index is stronger, though much of that is due to Russia and Brazil.
Latin America and EMEA for now, but then it is Asia’s turn again
Emerging market equities have suffered another decade of underperformance versus developed markets, although recently, this has been more pronounced relative to the US than to the rest of the world.
Given that sentiment has already improved in developed markets as lockdowns are eased and that valuations, particularly in the technology sector, have become elevated, this may be a good time to rotate into emerging market equities.
In the near term, the commodity-sensitive regions – Latin America and EMEA – can be expected to outperform as oil and metal prices recover, and China may lag due to US-election related tensions.
Over the medium term, however, the big fiscal stimulus in China should feed through to the rest of the region and the dominance of Asia, and in particular China technology, should reassert itself.
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 Europe, Middle East and Africa
 The MSCI World captures large and mid-cap representation across 23 developed market countries.
 For a definition, see https://www.investopedia.com/terms/p/price-to-bookratio.asp
 For a definition, see https://www.investopedia.com/terms/p/price-earningsratio.asp
 Broad tech includes information technology, internet retail, movies & entertainment, and interactive media industries.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.