Emerging markets punched above their weight in 2020. Despite the challenges of a global pandemic and recession, the MSCI EM Index returned 18.5% as earnings slipped -9%, and GDP declined -2.0%. In comparison, the S&P 500 Index rose 18.4%, earnings fell -13%, and GDP contracted by -3.5%. Performance has so far kept pace in 2021.
When investors approach emerging markets, it is important to remember that EM GDP is not the same as the EM equity market. The country composition and weightings between the two can vary significantly. As such, we believe investors’ views on the EM aggregate macro are less critical than the outlooks for highly-weighted, investment-relevant countries such as Taiwan, China, South Korea, India, and Brazil, which make up 80% of the index.
Source: International Monetary Fund, MSCI, and GSAM. As of December 31, 2020.
Exhibit 1 illustrates this relationship between equity weights (represented by the width of bars on the x-axis) and economic impact (represented by the height of bars on the y-axis) in the EM complex. In East Asia, which comprises a large proportion of the index, virus containment has been early and effective and there has been limited impact to aggregate GDP estimates. Equity returns have been pulled forward, and there is a clear path to recovery. In India and Brazil, where there has been more sustained economic damage, markets may have even more room to run.
Earnings growth has also been resilient, especially in the investment-relevant countries. As Exhibit 2 shows, EM earnings are expected to outperform their DM peers with shallower declines in 2020 and strong recoveries in 2021 and 2022. The result is cumulative earnings growth of 43% over this period, with the strength broad-based across countries.
Source: Goldman Sachs Global Investment Research and GSAM. As of March 12, 2021.
The combined tailwinds of cyclicality, commodity exposure, China sensitivity, and pockets of deep value may lead EM outperformance beyond the occasional short-lived bursts and become something more sustained. We believe EM equity will be a strong contender for investor interest in 2021. Even so, we continue to recognize that repeatable alpha generation in emerging markets comes from investing in companies rather than countries as the opportunity set remains highly idiosyncratic.