Year of the Ox outlook: Will emerging market equities outperform developed market equities?
Every Chinese New Year, AsianInvestor makes 10 predictions about developments that will affect global financial markets and the portfolios of Asian investors, especially asset owners. Today we consider the potential for emerging market equities to be a star asset class for the year, offering returns ahead of developed markets.
Will emerging market equities outperform developed market equities?
Emerging market equities finally enjoyed a rewarding 12 months during 2020, not only beating the performance of developed market equities but offering strong returns in general. The MSCI Emerging Markets Index, for example, returned 18.3% for the year, comfortably above the still impressive 15.9% provided by the MSCI World Index for the first time since 2017.
That trend looks likely to continue this year, in large part because of buoyant economic recoveries. Many emerging markets, especially in Asia, were able to limit the initial virus outbreaks far faster than developed markets in Europe and North America, and have kept down the number of infections since.
China may have been the origin of Covid-19 but its rapid clampdown combined with a splurge in public debt spending enabled it to record positive economic growth of 2.3% last year, and it should accelerate further in 2021. An accelerated economic recovery is also expected in India, Indonesia and Vietnam.
In contrast many developed markets, particularly those based in Europe, have seen a resurgence in Covid outbreaks and been forced into another round of lockdowns. Their economies look unlikely to gain momentum for several months. The good news for them is that vaccine rollouts have begun and should be more rapid and universal than in emerging markets.
However, a swift vaccine rollout and economic recovery among developed markets is also good news for emerging economies, as the recovery of the former should spill over to them as well. According to Goldman Sachs Asset Management (GSAM), developed markets should enjoy economic growth exceeding 5% in 2021, whereas emerging markets could rise by around 6%.
Meanwhile, central banks appear unlikely to tighten the money spigots anytime soon, meaning markets appear set to remain flush with liquidity even as economies recover. These expectations already led to market rallies in the final months of 2020, and while there may be periods of correction, there are few signs there will be protracted drops this year.
Another consequence of the Federal Reserve’s loose monetary policy in particular is that the value of the US dollar is relatively low, which will be good for emerging markets. And the Biden Administration’s much-discussed $1.9 trillion US Covid stimulus plan currently working its way through Congress should also be good for markets globally.
While geopolitical tensions between the US and China appear unlikely to greatly decrease, and an easing of sanctions appears unlikely this year, relations between the countries should become more predictable and be conducted largely through diplomatic channels. Even the prospect of a less mercurial US approach should the lower headline risk for Chinese stocks.
Across the world, technology and innovative sectors are likely to enjoy strong popularity and increased revenues. US technology stocks like Zoom and Amazon continue to be bolstered by digitalisation trends, such as work-from-home, but e-commerce players in emerging markets like Indonesia should also enjoy more popularity in line with growing smartphone penetration, as will cloud technology infrastructure companies.
Meanwhile, Taiwan and Korea should benefit from the structural growth in technology hardware and diversification of the global technology supply chain. Semiconductor chipmaker Taiwan Semiconductor Manufacturing in particular saw gains on the news that US rival Intel would increase its outsourcing.
Another factor supporting the performance of emerging market stocks is their relatively low relative valuation. While they have historically traded at a discount to their developed market peers, their exceptionally low current valuations make them particularly attractive. Tim Love, investment director of emerging market equities at GAM Investments, noted that the average price-to-book ratio of emerging market equities stood at 0.9 as of early February, compared with 3 times at its 2007 peak.
Some equity strategists also believe 2021 could finally witness the much-ballyhooed ‘great rotation’ of money from growth stocks to value stocks (those that trade cheaply in relation to their earnings), after following last year’s strong rallies. There is plenty of room for scepticism about such claims –growth stocks have continuously outperformed value shares for almost a decade. However, were it to occur it could greatly benefit emerging markets, which are typically dominated by large industrial and cyclical companies.
Environmental, social and governance (ESG) considerations are also likely to play a role. Tighter regulation, such as incoming European Union disclosure rules, a growing awareness of sustainability and the US’s re-joining of the Paris Climate Agreement will boost the appeal of ESG-friendly stocks.
This should most benefit stocks in developed markets, which have faced more pressure to take ESG seriously. However, a rising number of Asian markets are also pledging carbon neutrality and their asset owners have begun adding ESG principles into their investing approaches.
Ultimately, this array of trends appears set to benefit emerging market equities more than their developed counterparts over the Year of the Ox. However, the prospects for both are reasonably good. Within emerging markets, Chinese stocks in particular could enjoy strong performance, while the US’s stock markets appear better set to perform than those of Europe.
All-told, 2021 looks like a good year for global equities. Assuming, of course, the world doesn’t experience any market shocks as large as the Covid pandemic.
Previous Year of the Ox outlooks:
Which Asia Pacific countries have the most to gain, and the most to lose, from a Biden presidency?
Will inflation offer any unpleasant surprises?
Will investor enthusiasm help Hong Kong and Shanghai's bourses break equity fund-raising records?