Emerging markets or industrialized nations?
Dr. René Dubacher
Financial Markets
The MSCI World Index reflects the stock market development of over 23 industrialized nations, while the MSCI Emerging Markets Index reflects the development on the stock exchanges of the most important emerging markets.
The MSCI World Index reflects the stock market development of over 23 industrialized nations, while the MSCI Emerging Markets Index reflects the development on the stock exchanges of the most important emerging markets.
Emerging market equities are expected to outperform over the long term with higher risks - due to higher economic growth. Emerging market economies are at an earlier stage of development and therefore naturally grow faster than the saturated economies of developed countries. This is the "base case" for the appeal of emerging markets as an investment region.
The following table compares the index performance ("net returns") in USD as of November 29, 2019:
Emerging markets shares in comparison
In the longer term, since the end of 2000, this has also been true: the "emerging markets" are yielding slightly more than 3% p.a. better than the industrialized nations. In the last 10 years, however, the opposite has been the case. Since the end of the 2009 financial crisis, emerging markets have lagged the performance of the MSCI World by more than 5% per year. At first glance, a disappointing performance. However, a differentiated view shows that the outperformance of the industrialized nations can largely be attributed to the performance of the US. Since the financial crisis, the US market has returned 13.45% p.a., more than twice as much as the MSCI World ex USA with 5.67% and a meager 3.33% for the emerging markets. Over the last 5 years it looks even better. The performance of emerging markets and developed markets (ex USA) is virtually identical.
The following chart shows the index performance over the last 5 years of MSCI World ex USA and emerging market equities:
MSCI World ex USA vs emerging market equities
The emerging consumer
The investment theme of the future in emerging markets is the emerging consumer. Economic growth puts money in people's pockets, and thus these people will consume more products and services, driving local market growth. It's a very simple dynamic: when incomes rise, even the most frugal person usually starts to raise their standard of living.
History has shown this pattern many times in different countries. When productivity rises, jobs boom. Wages rise to attract and retain the best talent. At the same time, people seek better education to qualify them for those jobs. Now that consumers are earning more, they will spend some of this new found income on improving their family's lifestyle.
The following graph shows the World Bank's expected consumption growth of the key "Middle Class" group over the next 10 years. Source: World Bank, World Development Indicators Database
Expected growth in consumption
Once this process is set in motion, growth is continuously positively influenced, ideally all the way to the status of a developed economy.
Outlook for 2020
Current economic and political conditions do not really favor emerging markets compared to global equities. The US dollar remains strong. The full resolution of the trade conflict between the US and China is a long way off. Political and social unrest in Hong Kong and countries like Chile make emerging markets vulnerable compared to developed markets.
However, this does not mean that the outlook is gloomy. We expect global GDP growth to improve next year, supported by less political tension. As the final chart shows, the emerging market manufacturing PMI has been stable above 50 for three consecutive months and continues to outperform developed markets. In addition, we expect the U.S. dollar to weaken in 2020. The combination of these two developments increases the potential for emerging markets to outperform.
PMI Developed vs Emerging
