Emerging markets diverge from the playbook
For emerging market investors, the scenario has been familiar for decades: When commodity prices rise, emerging market equities rise too, and vice versa.
The logic is simple: the emerging world is the source (most) of raw materials. Whether you are bullish or bearish on global growth, you feel the same for commodities and emerging market equities.
But this year the narrative has changed. As a post-coronavirus recovery became visible late last year, both sets of assets rose. Between early November and late January, the S&P GSCI commodities index and the MSCI Emerging Markets equity index each gained around 25%.
Since then, commodity prices have risen another 30%, while emerging market equities have stagnated.
A simple explanation is that there are fewer reasons than before for emerging market stocks and commodities to rise and fall together. The days when the MSCI EM Index was dominated by Latin American commodity producers are long gone. Today, companies from China, Taiwan, South Korea and India make up three-quarters of the index.
Technology, in particular, dominates. Information technology stocks represent 20 percent of the MSCI benchmark. However, Daniel Salter of Renaissance Capital, a specialist in emerging and frontier markets equities, says their true weight is almost double.
According to his calculations, including tech companies in sectors such as communications services and consumer discretionary, tech stocks make up 38% of the index. This compares to less than 5% for energy stocks and 9% for materials.
Nonetheless, commodities and emerging market equities continued, until recently, to move in tandem. It may simply be a reflection of investor appetite for risk. But there are also real reasons.
Often the driving force behind both sets of assets has been China. The country’s resilience to the pandemic – it was the only major economy to record growth in 2020 – might suggest that narrative was still alive. But concerns about precarious finances in parts of the Chinese economy have once again appeared on investor radars. Beijing has stepped up its scrutiny of the country’s $ 17 billion credit market, once again prioritizing financial stability over economic growth.
With the world’s second-largest economy unlikely to grow as before, the momentum behind commodity prices and emerging market equities has slowed. Fortunately for commodity producers, stimulus spending by the United States and President Joe Biden stepped in to keep demand boiling.
“A Chinese slowdown would normally translate into lower commodity prices,” said Ian Beattie, fund manager at Nedgroup Investments. “But there has been a compensatory boost from the Biden stimulus package and the economic reopening in the United States and Europe.”
A global recovery led by the United States and Europe should be good for emerging market exporters in general. But that prospect is undermined by the associated threat of inflation and rising interest rates.
“You can tell a really positive macro story, with the opening of the global economy, a return of tourism, the potential for a new commodities boom,” said Mary-Therese Barton, head of emerging debt. at Pictet Asset Management. “But on the other hand, we would probably be hard pressed to find a history of strong structural growth.”
She described the markets as clouded by uncertainty, which had been exacerbated by surprises in US jobs and inflation data. “Everyone expects surprises,” she said. “But how do we forecast when we get this magnitude of outsized surprises on US data?”
She’s not the only one to expect a bumpy ride. Simon Quijano-Evans of Gemcorp Capital, a longtime emerging market specialist, said investors were shocked by the amount of surprises in economic data and the confusion caused by unprecedented comparisons with a weak base last year. .
Many also accept the completely new experience of rising inflation – at least for those unfamiliar with the boom and bust in emerging markets.
Investors from developed countries, Quijano-Evans said, appear poised to put the pandemic behind them. But the global situation is still uneven, with the number of coronavirus cases still high in parts of South America and the possibility of new variants a lingering danger until the global rollout of the vaccine matches that of the world. rich. The decoupling of commodities and emerging market equities, he said, was a taste of what’s to come.
“I’m pretty sure there are going to be a lot of surprises that we don’t think about now because we’ve never been in this situation before,” he said. “Many of us thought 2021 would be easier than 2020. But dealing with the ripple effects of Covid-19 in the real economy will last until at least 2022.”
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Robert Armstrong dissects the most important market trends and explains how the best minds on Wall Street are reacting to them. Register now here to receive the newsletter directly in your inbox every day of the week