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Don’t Expect EM ex China Performance to Impress

Stuart Brown

Emerging markets ex China equities have underperformed their DM peers this year due, in part, to greater economic and political challenges, which have weighed on sentiment toward the bloc. We expect these issues to persist into next year and are skeptical that EM ex China equities can outperform DM equivalents.

The COVID-19 vaccine rollout has accelerated in emerging markets, but several forces are likely to weigh on EM ex China. The difference between EM ex China 2022 GDP growth expectations (5%) and the same figure for DM (4%) is at its lowest point in decades. Linked to this fact is that EM economies are expected to rein in fiscal spending more than DM peers. But EM ex China policymakers face a catch-22 if tempted to draw on fiscal levers to support growth, as markets would likely balk at any such move over fiscal sustainability fears. Further, several EM ex China central banks have lifted policy rates this year—well before DM counterparts—and will likely continue doing so in 2022. EM ex China’s export-heavy economies are also at risk from China’s economic deceleration given their large trade exposure. On the political front, the situation seems set to remain volatile, particularly in Latin America, which could dampen market appetite. Lastly, we also expect the US dollar to rise modestly in 2022, which is yet another hurdle for EM ex China equities.

Still, the fundamental outlook is constructive, which we expect will limit the extent of any underperformance by EM ex China equities. Recent market pricing has created an attractive relative valuation discount versus DM, all while relative EPS expectations have outperformed. EM ex China return-on-equity has also rebounded sharply and should remain healthy in an environment of solid demand, semiconductor shortages, and sticky commodity prices. But DM has maintained its ROE advantage thanks to near record-high US margins. EM ex China could gain in this regard if higher wages, supply disruptions, or regulatory developments threaten US profitability. That said, we expect any relative EM ex China ROE improvement will be modest and not significantly influence performance.

December 31, 2019 – November 30, 2021 • EM ex China vs Developed Markets

Sources: Bloomberg L.P., MSCI Inc., and Thomson Reuters Datastream. MSCI data provided “as is” without any express or implied warranties.
Notes: EM ex China and Developed Markets are represented by the MSCI Emerging Markets ex China Index and the MSCI World Index, respectively. Total return data for all MSCI indexes are net of dividend taxes. The chart is rebased to US$100 on December 31, 2019


Stuart Brown, Associate Investment Director, Capital Markets Research