Emerging, Submerging, and Diverging Markets
MSCI China (Blue) and MSCI India (Orange) Indexed to 100 over Five Years
Source: Bloomberg
Emerging Markets often get lumped together as a single asset class. However, this increasingly doesn’t do this diverse group justice as there are often very different stories unfolding. The chart above shows the performance of the stock markets of the two largest components of the Emerging Markets index, China and India. China currently makes up 24.4% of the MSCI Emerging Markets Index, while India is second at 16.9%. The chart above shows the 5-year capital performance of these markets with India up 91.5% and China down 27.5%. Sentiment towards Emerging Markets has been poor for a decade. The chart below shows the shares outstanding in the most popular Emerging Markets ETF (EEM US) which have more than halved over the period.
iShares MSCI Emerging Markets ETF
Source: Bloomberg
There are many important factors that have been driving this, not least the bull market in the US dollar over the period which tends to hurt Emerging Markets. However, much of the recent woes have been centred around China. As China’s relations with the US have become strained and market participants have become more attuned to the importance of geopolitics in investing, especially in the wake of the Russian invasion of Ukraine, outflows have accelerated, and China’s underperformance has continued. China has become “uninvestable” for many.
Despite the overall outflows from the EM universe, India has thrived. Clearly, it has benefited from aspects of the “friend-shoring” dynamic as many Western firms have rushed to reduce their dependence on Chinese supply chains. For fund managers looking for EM exposure ex-China, India is the obvious home.
Nevertheless, most investors with exposure hold a diverse portfolio of Emerging Markets equities and the weakness in the largest component has depressed overall returns. Judging whether idiosyncratic China risk is something they should be exposed to is a key decision for portfolio managers. However, sentiment is so bad that the bar for recovery is low. Anything less than outright decoupling would be a bullish surprise. From the Chinese side, who are no strangers to getting involved in their domestic financial markets, providing a bid for foreign investors to exit would surely feel unnecessarily generous. Better to wait until the foreigners are out before stepping in.
China is absolutely a significant risk and there may be trouble ahead. However firstly, if things really get that bad, their effects will be felt a lot more widely than just the Chinese stock market. Secondly, if they don’t and/or the Chinese feel the time has come for a bull market, the outperformance could be dramatic with investors underexposed.