EM EQUITIES, LOOKING FORWARD
The lens of history combined with an understanding of how economies across the globe are changing can provide valuable insight for emerging markets (EM) investors seeking long-term capital growth. EM have historically rebounded strongly after periods of crisis. The repetition of this pattern, in its initial phase, appears to have started during the first half of this year with EM equities rallying in response to growing optimism about the potential containment of Covid-19.
Whether this optimism continues is hard to predict, with many epidemiologists anticipating increasing numbers of new Covid-19 cases as economies continue to re-open. Nevertheless, we believe the first half of 2020 reinforces our thesis that EM often repeat a pattern over long-term periods in response to crises. In this commentary we explore this pattern and explain how economic changes in developing countries may bode well for EM equities.
Emerging Markets Rally After Dropping Dramatically
The MSCI Emerging Markets Index dropped approximately 33.9% from January 17 to March 23 in response to fears over an anticipated global recession resulting from the pandemic. While the decline was similar to that of the S&P 500 and MSCI EAFE (Europe, Australia and the Far East, or developed markets ex U.S.), several EM countries experienced sharper falls with Brazil and Russia declining more than 50%. After reaching a low in late March, the MSCI Emerging Markets Index rebounded 31.2% as of June 30. With the pandemic still expanding rapidly in many
developing countries–specifically Brazil and India–but appearing to moderate in the U.S. and other developed countries, the S&P 500 and MSCI EAFE indices outpaced EM, generating 38.5% and 31.5% returns, respectively, as of June 30.
Understanding Market Cycles
The pattern of EM securities rising more sharply than the U.S. and other developed markets (DM) after a major crisis is not unusual. For EM, a crisis can cause investors to flock to the safety of the U.S. dollar, treasuries and other safe havens, such as the Swiss franc. During the stampede, certain EM assets–equities, debt, and currencies-can experience reduced marketability and liquidity, thereby exacerbating price declines. Additionally, many developing countries are leveraged to global growth and trade flows and are reliant on external funding and direct investment. These factors, in turn, can reinforce negative news regarding global growth and other factors, which sustains a negative feedback loop.
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