14 Apr 2021
09/04/2021| Nick Price, Emerging Markets
EM equities have begun to rally after a protracted period of relative underperformance. Meanwhile, supply constraints, stimulus and a transition to a greener economy lend support to commodities. Fidelity Emerging Markets Fund Manager Nick Price looks at historical correlation of EM equities with commodities, which suggests that the breakout could be sustained.
Following a protracted period of underperformance, emerging market (EM) equities have stabilized as export and domestic data indicates accelerating demand. When we examine the EM Index versus the S&P 500 Index, it has advanced above the key downtrend line from 2010 onwards. This measure of relative strength is important because it captures the close historical correlation of EM equities with commodities. This correlation may not continue in the future, but it provides helpful context for markets today.
| Mar 16 - Mar 17 | Mar 17 - Mar 18 | Mar 18 - Mar 19 | Mar 19 - Mar 20 | Mar 20 - Mar 21 | |
|---|---|---|---|---|---|
|
MSCI EM |
17.7% |
25.4% |
-7.1% |
-17.4% |
58.9% |
|
S&P 500 |
17.2% |
14.0% |
9.5% |
-7.0% |
56.4% |
|
WisdomTree Enhanced Commodity ETF |
2.8% |
0.1% |
-6.4% |
-19.8% |
38.8% |
Past performance is not a guide to the future.
Emerging markets have evolved, but commodities continue to play an important role in many of those economies. In the aftermath of the global financial crisis, the world’s largest miners exercised huge restraint: capex peaked in 2012, then dropped before staging a small recovery from 2017 onwards. Then the pandemic struck, and 2020 activity was impacted by Covid-19. Supply constraints are now joined by huge stimulus and a transition to a cleaner, greener economy, driving demand up and lending support to commodity prices.
A sizeable US fiscal deficit could prove to be negative for the dollar and positive for both EM securities and commodities. From 2020 through 2024, the US’s total fiscal spend could approach 40 per cent of 2019 GDP. This represents a secular step change and argues for structurally low interest rates to be maintained.
We are yet to ‘escape’ the pandemic, but there are reasons to be optimistic. Vaccination programs are accelerating the world over and EMs feature some of the highest-ranking countries in terms of total doses per capita (UAE, Chile, Turkey, Poland). EM is also home to those countries that have dealt with the pandemic most effectively (China, South Korea, Taiwan). Finally, with a higher share of younger people in places like South Africa and India, a number of large EM economies will be able to vaccinate their more susceptible people in a relatively short period.
EMs continue to trade at a wide price-to-book discount to developed markets, and investor positioning is light, suggesting there may be less risk of a large correction if the optimism over vaccination programmes proves premature. As the market starts to consider a more reflationary backdrop and commodity demand rises further, ‘cheaper’, more cyclical EM stocks are likely to benefit, particularly those in emerging Europe and Latin America.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in small or emerging markets may be more volatile than other more developed markets. The Fidelity Emerging Markets Fund has the potential of having high volatility either due to its composition or portfolio management techniques. It can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.