20 January 2020
Although 2019 was a strong year for global equity markets, there was fairly high dispersion between developed markets (DM), which recorded one of their strongest years since 2009, and emerging markets (EM), which lagged their DM peers significantly.
A large part of this underperformance can be attributed to slowing global growth due to fears around trade war. Such fears hit China, which saw its growth slow to nearly 6%, well below the previous estimates that it could hold a sustainable 7% growth rate. However, with the recent signing of a phase one trade deal, and potential further concessions to come on tariffs between the US and China, this may help the economy to recover slightly if trade can pick back up.
Another factor that caused EM equities to underperform last year was significant geopolitical tensions, especially with regards to civil unrest in Latin America and Hong Kong. Although these risks have not dissipated entirely, there has been some reduction in the escalation, with tensions seeming to cool somewhat in these areas.
Coming into 2020, EM equity valuations now appear modestly attractive relative to DMs; however, uncertainty persists, particularly with respect to earnings, trade tensions, capital flows and potential structural reforms. We believe there may be catalysts that, if triggered, might allow investors to realise value in EM equities, which include:
- A pickup in capital flows as EM benchmarks expand
- An abatement in US-China trade tensions
- Greater allocation to EM by global funds
- Structural reforms (e.g. pension reform in Brazil; corporate tax reform in India; land/public sector reform in South Africa; and energy reform in Mexico) showing through in improving economic fundamentals and GDP growth
Although, given the idiosyncratic risk that persists in EMs, we view a broad allocation to MSCI Emerging Markets as preferable in order to mitigate some of this risk. Investors wishing to take a more focused view on the improving sentiment between the US and China may want to use a more targeted MSCI EM Asia approach in order to capture the potential upside.