Will Emerging-Market Equities Finally Outperform in 2020?

Following outflows from emerging-market equity funds during the first three quarters of 2019, significant inflows are occurring in the fourth quarter as investor sentiment becomes more positive, anticipating stronger performance for this asset class in 2020.

Possible future outperformance for emerging markets would follow an extended period of underperformance. Over the past 5 years, the annualized total return for the MSCI Emerging Market Index is 3.43%, less than half the 7.14% return for the all-country MSCI ACWI Index. Over the past 10 years, the comparison is worse: 2.14% versus 8.43%. How likely are we to see a reversal next year?

There are three main factors underlying the strengthened sentiment for emerging-market equities:

First, the prolonged period of EM underperformance has left equities in EM markets inexpensive compared to equities in developed markets, particularly the US market. This valuation gap, while it could continue for some time, should over the long run work towards improved EM performance, particularly in view of the expectation that economic growth in the emerging markets will continue to be stronger than that of developed markets. Also, EM earning revisions have been improving.

Second, the rally in EM stocks has been stimulated in part by signs that the global economic slowdown that began in the first half of 2018 is now bottoming out. The data thus far are mixed. There are some convincing signs of stabilization, but we do not yet see clear evidence that a strong, synchronized rebound in growth will develop. What looks more likely is a modest recovery in global growth in 2020, with reduced but continued downside risks. An important positive development, particularly for emerging-market economies, is evidence that the global decline in manufacturing has bottomed out. The Markit J.P. Morgan Global Manufacturing PMI for November was at a seven-month high. At 50.3, this indicator has, for the first time since April, moved above the 50.0 line that divides expansion from contraction. Global manufacturing production increased for the third successive month. Industrial activity is advancing in most regions, including the US, the Eurozone, China, and Brazil. Global new export orders imply a stabilization in world trade. These orders suggest that world trade volumes will be advancing at a 1% annual rate, reversing the decline in the third quarter, which fell at the fastest pace since late 2009.

The third development behind the improved sentiment towards EM equities is renewed optimism on the trade front. The US-China trade war and other trade disputes have been a major cause of the global slowdown in economic growth and declines in world trade and manufacturing. The signals that a “phase one” trade agreement between the US and China may be reached this month or in early 2020 are certainly encouraging. Finalization in Congress of the USMCA, the US-Mexico-Canada trade agreement that replaces NAFTA, also looks likely. And both the US and the EU have indicated that the threat of the US’s imposing tariffs on European autos has receded. These would be positive developments. However, we expect that considerable trade uncertainty will continue in 2020. Most importantly, the United States and China will continue to have very difficult issues that will not be resolved in a phase one agreement. Tariffs are unlikely to be completely rolled back, and the confrontation between the two competing countries will continue on a number of fronts. The technology war and its links to security issues are likely to be particularly challenging. Also, President Trump’s attraction to using tariffs shows no signs of abating.

Despite these reservations regarding the likely pace of a recovery in global economic growth and the probably excessive optimism on the trade front, emerging-market equities as an asset class do look well-placed to outperform. The attraction of their relatively low cost and improving earnings has been cited. The acceleration in EM economic growth rates is projected to be more robust than the rather weak advances that are likely in the developed-market economies. This trend should strengthen despite China’s economy looking likely to be headed for continued slowing, from 6.6% growth in 2018 to 6.1% this year and a rate under 6% going forward. The anticipated acceleration of a number of emerging-market economies in 2020, including Brazil, Mexico, India, Turkey, South Africa, and Russia, follows weak performances earlier in the current year. The Brazilian economy, for example, is already showing strong signs of a healthy recovery following a severe recession. A sweeping program of deregulation and privatizations promises to give important support going forward, encouraging improved investment activity. The iShares MSCI Brazil Capped ETF, EWZ, has gained 6.2% in the past 3 months and 17.1% year-to-date as of December 8, on a total-return basis. That gain already reflects outperformance in the past three months compared with the global all-country iShares MSCI ACWI ETF, ACWI, which gained 5.5% and was considerably above the 3.9% gain for the iShares MSCI Emerging Market ETF, EEM. Other markets we are monitoring with interest include Mexico in Latin America and Taiwan, South Korea, Malaysia, Philippines, Indonesia, India, and China in Asia.

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.