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Performance and drivers of emerging markets vs developed markets

‘There are all sorts of reasons why we can’t see emerging markets starting to outperform next year’: Peter van der Ross – Stanlib Multi-Strategy.

SIMON BROWN: I’m chatting now with Peter van der Ross, portfolio manager at Stanlib Multi-Strategy. Peter, I appreciate your time today, talking about emerging markets. Before we delve into some of the mechanics around it, you’ve done some research on emerging markets versus developed markets, and the performance and drivers of that performance. What can you share with us about that?

PETER VAN DER ROSS: Simon, thank you. I guess the first complication is that emerging markets are a catchall, not one thing. But in the interests of brevity let’s try and summarise.

Emerging markets as an asset class started to gain favour in the late 1980s, and in 1998 the MSCI introduced their Emerging Market Index. If one looks, since then, and compares the performance of the main MSCI indices – emerging to developed markets – it looks like a big up/down pattern. So you’ve had two cycles really where emerging markets outperformed from the late eighties to about the mid-nineties. That was driven by, I suppose, this new promise of the structural growth outperforming. A lot of capital flooded into emerging markets and things started unravelling around the mid-nineties. We had a series of emerging-market currency crises eventually culminating in the Asian crisis in ’97, ’98.

Then of course, in the late nineties, we had the IT bubble in the US. That was the first big swing in the late nineties when developed markets started outperforming emerging markets – but it was mostly driven by the IT bubble.

Then things changed again in the early 2000s. Then we had the Chinese sector really kicking in. So from 2000, 2001 until actually 2010, I think we all know what happened in China – a massive infrastructure boom. That really created a rising tide that lifted most emerging markets, because most emerging markets are involved in the commodity complex somehow, mostly commodity exporting nations.

Since then, again, you had the rise of both the Internet of Things, social media. So for the last 10 years developed markets [DMs], have outperformed emerging markets [EMs], but again mostly driven by the structural outperformance from US techs, so the Nasdaq, for example, over the last 10 years has done about 20% per annum.

So you’ve had this big sort of up-down pattern; point-of-point EMs have not really outperformed DMs; they certainly don’t look like the structural outperformer they looked likely to be, what, 30 years ago. They’re also not a high beta sort of geared play on some kind of global equity cycle because actually, the relative has been driven by thematics, either IT or infrastructure spend rather than GDP growth dynamics.

SIMON BROWN: Yeah. I take your point there – it’s not the GDP, it’s … what’s the underlying story. If we then bring it to the now, we’ve had a booming commodity cycle; certainly it has helped South Africa, although that’s cooling a bit in the PGM space. Of course, we’ve got the pandemic ongoing at the moment.

Looking into next year – and I appreciate a year is a short time in the investment world – where would you be expecting emerging markets to perform?

PETER VAN DER ROSS: We still struggle to see why they would outperform next year. Remember, China is the second-biggest economy in the world. It dominates the EM landscape. They have some specific problems there [in] their property sector. There’s significant stress we think still to come in that sector; a lot of bond maturities are due in Q1 next year. Then there’s some Chinese politics at play next year as well. [President] Xi Jinping is looking to secure an unprecedented third term. Their key policy conference will be next October; he won’t be wanting to rock the boat before then.

So, for whatever reason, or in fact for a multitude of reasons,  their labour force is now shrinking. So the whole policy mix and policy objective is changing rapidly in China. They’re sitting on their hands, not really stimulating as they probably would have if their property sector was struggling 10 years ago as it is now, but they’re not stimulating.

In the meantime, the US Fed one would think is going to start responding to inflation. The dollar is looking strong. Again, that’s typically not good for emerging markets. So there are all sorts of reasons why we can’t see emerging markets starting to outperform next year. The list goes on and on. But we would caveat that by saying at any point in time there’s a long list of reasons why markets shouldn’t go up and one knows to be alive to the price action, what the market’s telling you.

Right now the price action is not telling you that the difficult times for EMs are over.

SIMON BROWN: We’ve been talking EMs sort of broadly as a concept, and you were touching a whole bunch there on China. Of course, South Africa is an emerging market. Is an argument… for certain perhaps regions, even countries within the EM space?

PETER VAN DER ROSS: Well, I guess we’d go back to our initial caution in looking for structurally outperforming regions, because for all the logic in the world *** often disappoint. The one interesting place is possibly India, but even that country has really struggled against the S&P in the last decade. Many EMs are typically whipsawed by global dynamics first and foremost; and then secondly there’s risk of the odd own-goal, with Turkey with their monetary policy. Argentina would be, I guess, a chronic series of debt defaults.

We don’t tend to look for geographies that look like structural outperformers. Our inclination is more to try and package global ideas or themes like energy shortage, or like ESG into baskets that cut across markets. Those could be developed or emerging markets.

In other words, we’d rather try and divide up the world along thematic rather than geographic lines, because at least we can understand the thematic lines better – and then one’s not beholden to politics or a particular region.

SIMON BROWN: I take your point. As you say, they kind of get whipsawed by those global themes anyway. So find those thematic themes.

We’ll leave that there. That’s Peter van der Ross, portfolio manager at Stanlib Multi-Strategy. Peter, I appreciate the time.

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Unsurprisingly, performance follows the dollar. When the dollar leaves US bonds and goes to emerging markets, they will outperform. If dollars go to US bonds, emerging markets underperform. The dollar is the air that inflates the balloon of relative performance.

Weaker dollar = rising commodity prices = more dollars in emerging markets = rising profitability of commodity producers = emerging market outperformance. Dollar liquidity determines the economic realities like Debt/GDP, Budget Deficit, and unemployment rates in emerging markets.

The investor who tries to call the trend of emerging market outperformance is actually a currency speculator. Good luck with that one.

End of comments.

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