We see three key catalysts likely to affect emerging-market (EM) equites this year: the response to the pandemic, the possibility of synchronized growth across developing countries and export linkages.
The impact of the COVID-19 outbreak and the response to it have varied widely across the world. Perhaps predictably, countries that imposed stringent lockdowns, tested and tracked their citizens and thoughtfully reopened their economies with caution have rebounded sooner than the rest. In this context, China, Taiwan and Korea (accounting for >65% of MSCI EM) have proven to be world-beaters; we think their economies may regain normal levels of activity as soon as the second quarter. In fact, China and Taiwan were among the few countries to deliver positive real GDP growth in 2020. We believe the range of outcomes will be narrower for them in 2021. For countries more affected by the pandemic, including most of Latin America, India and Russia, we believe we may see further upside from the vaccine rollout. But we would also caution against new waves.
We anticipate a synchronized GDP growth rebound in 2021. All 27 EM countries are expected to deliver positive real GDP growth for the first time since the global financial crisis. While developed market governments have resorted to significant fiscal stimulus by way of unemployment benefits or furlough schemes, EM governments have by and large been more restrained. Inflation has been benign due to a combination of demand destruction and lack of avenues for consumer spending, whereas the drop in imports helped strengthen current account balances in some countries. We believe monetary and fiscal policy will remain supportive in most emerging markets in 2021.
A gradual recovery in developed-market business activity should be good news for EM exports and an another catalyst for growth in these countries. In past cycles, an export recovery would have been driven primarily by commodity-heavy industries in EM countries. This is less so now that these sectors account for only ~15% of the MSCI EM Index. There will, however, be an impact through consumer and financial companies in commodity exporting regions like Latin America, the Middle East and Russia. But we think we’re most likely to see this play out through the semiconductor cycle. We are witnessing a surge in demand due to remote working arrangements, alongside well-entrenched long term trends of 5G infrastructure, data centers, automation and artificial intelligence. This makes for a supportive environment for earnings growth to recover from the anaemic levels seen over the last two years.
As it relates to valuations, we recognize that one-year forward multiples have moved up considerably, but we would highlight three points:
First, considering the prevailing ultra-low interest rate environment is likely to persist for the foreseeable future, we believe it is not unreasonable for high growth assets to trade at a premium to their history.
Second, the EM universe today is more domestically orientated with lower reliance on commodities than in previous cycles. In their place, higher quality/growth consumer and technology companies account for more than 50% of the MSCI EM weighting, up from 30% in 2008. We think the historical average is biased to the downside and that current valuations appear attractive on a sector-adjusted basis.
Third, the collapse in 2020 earnings and resultant low base effect will likely drive above-trend earnings growth in 2021 and 2022, which may not be entirely captured by a one-year forward multiple. Relative valuations are compelling, as EM’s projected ~30%+ earnings growth over the course of 2021 outpaces their developed markets (DM) counterparts. Considering that corporate fundamentals typically explain ~85% of EM equity performance over any 10-year period, we believe this to be an interesting entry-point into the asset class. Indeed, EM equities have seen record inflows since November as investors continue to close their underweight positions. For those wondering whether they have missed the bus, we would point out that if investors were to revert even to historical average allocations, the bulk of the inflows should be in front of us.
 Source: Datastream, as of Dec-20. Past performance does not guarantee future results, which may vary.