Emerging Markets Beckon, But Advisors Should Be Choosy

Last year, the MSCI Emerging Markets Index returned 17% while the S&P 500 climbed 18.4%. Lagging is lagging, but that was one of the narrower gaps investors have seen in recent years.

In the six years spanning 2015 through, the emerging markets benchmark beat the S&P 500 just once – in 2017. So it's understandable that advisors are reluctant to embrace emerging markets equities on clients' behalves, but as a result, client portfolios may now be under-allocated to the asset class at a time when the outlook is improving.

Remember the about the performance of developing world equities in 2020. China was the starting point of the coronavirus pandemic and the world's second-largest economy is usually the largest geographic weight in essentially every cap-weighted emerging markets benchmark.

The health crisis weighed on global technology supply chains, for a time pinching South Korean and Taiwanese stocks while oil prices plunged, crippling Russian stocks. Brazil has the second-most COVID-19 deaths, trailing only the U.S.

Said another way, the MSCI Emerging Markets Index trailing the S&P 500 by just 140 basis points in 2020 is impressive and could be a sign of more to come this year.

China Leads Resurgence

Owing to factors such as sheer economic might, a growing consumer sector and growth exposures, China is a primary reason developing world benchmarks perked up late last year.

“Within EMs, China demonstrated unique economic robustness in 2020,” said Global X analyst Chelsea Rodstrom. “The world’s second largest economy and the largest EM only experienced an economic contraction in Q1, before effectively containing the spread of COVID-19 and becoming the only major economy to post positive growth for the year. In Q4 2020, China’s economy continued to show strong resilience with economic activity further strengthening after two quarters of expansion.”

At the sector level, the Chinese equity market isn't quite as diverse as the U.S., but it's diversified relative to other developing economies. In fact, Global X offers a suite of 11 China sector ETFs. What's interesting is that, according to the issuer's research, of the 11 GICS sectors, nine of the China-specific equivalents outperformed the U.S. counterparts last year.

With Chinese economic activity rebounding and offering some of the best growth rates among the world's major economies, advisors may want to consider the growth/quality combination offered by Chinese companies that are consumer-facing and not controlled by Beijing.

More Than Just China

With China dominating most traditional emerging markets benchmarks, it's easy to view the country as the lone driver of returns for this asset class.

However, owing to the weak dollar and the global recovery, commodities prices are roaring back this year, providing a tailwind to an array of other geographic components in the MSCI Emerging Markets Index. As just one example, Russian stocks are soaring and the ruble is on a Bitcoin-esque tear to start 2021.

“Following a year full of volatility for commodities in which oil fell below zero and choked supply chains forced farmers to dump their goods, commodity prices across the board are bouncing back with a vengeance,” adds Rodstrom. “Oil is now above $60 a barrel, while metals prices have continued to climb because of shorter term supply constraints, accelerating demand, and inflation and infrastructure projects looming on the horizon.”

There's another benefit to the weak dollar. It lowers financing costs for emerging markets debt issuers.

That's relevant at time of still paltry yields on domestic government debt. Consider the J.P. Morgan EMBI Global Core Index, which tracks dollar-denominated bonds. It yields almost 4%.

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