For years, emerging market equities have been favored by many strategists for their strong potential growth and relatively cheap prices compared to developed market equities, but they frequently disappoint.
Even last year when the MSCI Emerging Markets Index climbed 18.4%, the S&P 500 gained over 60% more, up 30%.
This year, however, could be different, according to the emerging markets team at Grantham, Mayo, Van Otterloo & Co., led by Amit Bhartia and including Mehak Dua and Alvaro Pascual. They cite the smaller drawdown from peak to trough during the current pandemic-fueled crisis compared to six previous sharp drawdowns between late 1997 and early 2018, including the financial crisis of 2008. The average decline for those drawdowns was 41%; in the first quarter of this year it was 33%.
Whether the bottom was reached in emerging and developed markets during the first quarter remains to be seen given the continuation of the COVID-19 pandemic, but many emerging markets, such as China, Taiwan and South Korea, have seen a sharp drop in coronavirus cases. Others, such as Brazil and India, have not.
In a new research paper, the GMO emerging markets team outlines five critical changes that make emerging markets “more resilient today” than they’ve been in the past, using the MSCI Emerging Markets Index as the benchmark.
1. The weight of vulnerable countries in the index has declined significantly.
In 2012, over 30% of the index consisted of nine vulnerable economies including Brazil, Turkey and South Africa. Today they account for less than 20% of the index.
2. China’s weight in the index has increased substantially.
China now accounts for 40% of the MSCI emerging markets index and is less vulnerable than other emerging markets with the fiscal and monetary wherewithal to rebound from temporary economic setbacks.
Its government has spent only 5% of its GDP on fiscal stimulus during the pandemic, less than half the 11.5% it spent during the 2008 financial crisis and 13% of GDP spent by the U.S. this year, leaving it room to spend more if necessary.
3. Cyclical sectors hold a smaller share in the index.
In 2010, cyclical sectors such as energy and materials accounted for 30% of the MSCI Emerging Markets Index. Today they represent about half that, while internet and technology stocks account for about one-third of the index, making the index less vulnerable to the ebb and flow of the economic cycle.
Moreover, even the more vulnerable sectors in the index, such as Russian and Brazilian energy and materials sectors, are stronger, having reduced their debt-to-equity ratios.