Back Where We Started: The Outlook for Emerging Market Small Cap Stocks
If you have been lucky enough to be stranded in a safe – but unconnected – place for the last six or seven months, you’ll be forgiven for thinking that 2020 has been a pretty boring year for the markets. Your investments in emerging market (EM) stocks are likely flat. Did anything interesting really happen? If only.
We began the year quite optimistically, expecting greater than 40% growth in EPS1 – by far the highest increase forecast across the various global equity markets. This was welcome news, as earnings growth had been soft for a few years – pressures from global trade traumas and a stronger US dollar (since 2016) had been unwelcome headwinds for far too long. But investors were beginning to notice this newfound growth potential, as firms trumpeted their strong 2020 fundamental stories.
Unfortunately, along comes the COVID-19 pandemic, and it wipes out another year of profits for the asset class, along with many lives and livelihoods. I won’t begin to dissect the full impact of the pandemic in this note, but my instinct tells me a few things: The pandemic isn’t over, and the longer-term impacts are too difficult to assess. On the positive side, policy makers have acted strongly, and there is a public health response roadmap to take.
The market has shaken off the COVID shock – this has been the shortest bear market in history. From the end of 2019, 41% was wiped off EM small cap (EMSC) equity values (to the trough in late March), but they have since bounced back a whopping 64%.2
So, why are investors optimistic? I’d offer several reasons. The global policy response, especially from central banks, has been very positive for liquidity conditions across all markets. The extra liquidity has taken out, or perhaps more accurately, socialized, a good chunk of the risk in the global financial system. Central banks feared a collapse given the unknowns of COVID and have chosen the “big-bazooka” response, with over $6 trillion injected into the system from the big-three central banks (see Figure 1). The potential inflationary impact is a far more palatable policy choice versus a pandemic-induced collapse – which had to be avoided. If we add in the fiscal response, clearly some of this stimulus has found its way into global equities.