Emerging Markets equity performance across the world: a look back and a look ahead
Over the past month emerging markets (EM) equities have underperformed domestic markets (DM) by about 3%, especially since the start of December. After treading water for most of the past year, EM equities underperformed DMs (especially the US markets) sharply in September, and after a period of stabilization, have underperformed again over the past month, bringing their total underperformance over the year to between 10% and 15%. In this most recent bout of underperformance, the biggest laggards have been China, India and Taiwan. Taiwan also screens as the equity market index with the greatest underperformance relative to its underlying macro drivers over the past month, although, pretty much all Emerging Market Equity indices (outside of Korea) either underperformed or were in line with their macro drivers. Taking a slightly longer perspective over the past 12, 6 and 3 months, and looking at equity performance across 20 EMs, the list of the worst absolute performers and underperformers is populated by three groups of countries: (i) the CEE countries of Czech Republic, Poland and Hungary (ii) India and China (iii) and Taiwan.
This cast of underperformers highlights the three concurrent concerns that have challenged EM equities over the past year.
- First, the poor performance of the CEE countries simply reflects that they are most directly affected negatively by the European sovereign crisis in two ways: because they have very deep trading linkages with the Eurozone so that any sharp cyclical slowdown can be expected to extract a direct cost on their net exports. For the Czech Republic and Hungary, goods exports to the Euro area constitute more than 40% of GDP, and in the case of Poland it is about 20%. In addition, because several Euro area financial institutions are significant participants in the local banking markets, this means that the ongoing deleveraging pressures on those banks will likely imply a tightening in financial conditions and a pull back in credit in these countries. Reflecting these fears, these equity markets have been especially hard hit as the European sovereign crisis has deepened.
- Second, the poor performance of the large EMs, in particular China and India (and Brazil in parts of the year) has reflected the fact that it is hard for growth levered equities to do well when policy is being tightened in order to slow growth and dampen inflation. For much of the past year, the expectation of a peak in EM inflation over the summer and a turn in the policy cycle kept investors interested. But whereas inflation has indeed moderated as expected, the policy stance has not shifted decisively and the recent growth data have, if anything disappointed on the soft side.
- Third, with little prospect of an acceleration demand in the large DMs and policy constraining demand in the large EMs, the equity markets in the more open trading economies of Asia – Taiwan is the obvious example, but Singapore and Korea to a more limited degree – have suffered too.
At the other end of the spectrum of EM equity markets, there was a small group of countries that have managed decent performance throughout the year. This includes the ASEAN economies of Philippines, Indonesia, Thailand and Malaysia but also South Africa. Countries such as Philippines, Indonesia and Thailand are relatively less exposed to G3 demand and have less pressing inflation concerns than some of the larger EMs.
Looking ahead, if EMs deliver better equity market performance it will be necessary to see clearer signs of stabilization in the growth momentum in some of the larger EMs, specifically China, India and Brazil, with the prospect of acceleration further ahead. Our economic forecasts call for healthy growth in most emerging regions in 2012: 8.6% growth in China and 7.2% growth in India, and overall 7.1% growth for the BRIC economies. Based on these forecasts of we see the greatest upside over 12 months in the Asia (ex Japan) region. But a critical assumption of these forecasts is that policy responds in a timely manner.
To be fair, policy has already begun to shift in China – the recent cut in the Reserve Requirement Ratio being the most visible example – but we expect further steps towards easing, including rate cuts in China, India and Brazil over the next twelve months. EM equity is an important growth component to our asset allocation models over the next decade. Given relative attractive valuations - We have begun to increase our allocation in these markets, but still have room to increase further if opportunities arise. The PMI survey data at the start of each month should provide a timely indication of the growth momentum across the EM universe, and we continue to monitor these closely alongside nascent signs that the momentum our global leading indicator may also be turning.