Despite recent signs of improvement, investor sentiment about emerging markets has been fundamentally depressed over the past years, weighing on emerging market equity performance. One of the key concerns driving the asset class’s underperformance has been the disappointing economic growth in emerging market countries, especially when compared to the more resilient growth in developed markets.
It’s true that the once-strong emerging markets economic growth engine seems to have run out of steam in recent years. Gross domestic product (GDP) growth in emerging markets has declined not only on an absolute basis, but, more importantly, relative to developed markets.
“The difference in GDP growth rates between emerging and developed markets is a powerful factor in determining when one outperforms the other.”
The change in the relative pace of economic growth is important because of its predictive effect on relative equity market performance. Indeed, an analysis of the historical drivers of emerging versus developed market equities shows that the difference in GDP growth rates between emerging and developed markets is a powerful factor in determining when one outperforms the other. Emerging markets tend to outperform developed markets when the differential widens, and underperform when it narrows. That differential has been narrowing over the past years, explaining the underperformance of emerging markets.
That said, a closer examination of economic growth in emerging markets reveals a significant dispersion between GDP growth for manufacturing-led and commodity-led economies. The latter have collapsed while the former have remained stable over the past few years.
As global volatility subsides, we expect to witness greater differentiation in market performance as a reflection of the dispersion in economic performance.
Of course, that’s not the only factor depressing investor sentiment about the emerging markets. I’ll discuss others—including the potential impact of U.S. interest-rate hikes and a stronger U.S. dollar, fears of a hard landing and currency devaluation in China, and the collapse of the commodity complex—another time.