14 Feb 2018
In 2017, Emerging Market Equities have returned +37%, significantly outperforming US and Developed Market Equities, which returned +21% and +22% respectively1 – this marks the strongest absolute and relative performance in eight years. Looking to 2018, we believe Emerging Markets could be in the early stages of a multi-year recovery underpinned by 1) growth acceleration 2) earnings revival and 3) attractive valuations.
Economic momentum in emerging market (EM) countries has been accelerating and becoming more synchronized. Coming off the lows of the Taper Tantrum episode in 20132, EM economies have boasted a more supportive macro backdrop. Years of currency adjustments have culminated in healthier current account balances (a country’s balance of trade in goods and services + net income from abroad + net transfer payments from abroad), record low inflation differentials relative to developed markets (DM), undervalued currencies and reaccelerated GDP growth. The synchronized recovery in GDP growth across the EM universe since 2016 has reversed the trend of a narrowing real GDP growth differential between emerging and developed markets, and IMF forecasts point to a likely widening of the spread at least until 2022. As shown in the chart below, such a rebound in momentum has historically correlated with a multi-year structural outperformance of EM equities vs DM.
EM vs DM relative equity performance has historically correlated with EM vs DM GDP growth premium
Source: IMF World Economic Outlook, GSAM as of December 2017.
In addition, the long-term drivers of EM growth have shifted from commodities to consumption and technology, which are more sustainable in our view. After peaking at 40% of the EM equity universe in 2008, commodity sectors now comprise less than 15%, while technology and consumer sectors together make up more than 40%3 (see EM and the Commodity Conundrum).
Supportive macro fundamentals have fed into EM earnings, which have been recovering from a very low base. Return on equity (ROE)4 has been contributing positively to EM dollar total returns for the first time since 2011, and virtually all of the pick-up has been a result of growing margins and profitability. Furthermore, earnings momentum has turned positive for the first time since 2011 as MSCI EM reported earnings beat consensus estimates, prompting sell-side analysts to upgrade their 2018 forecasts. We believe we could be entering a synchronized multi-year cyclical recovery in earnings.
MSCI EM price-earnings ratio (P/E)5 is currently trading at a roughly 30% discount to the S&P 500, cheaper than historical average discount of 15%6. Following years of EM underperformance, global investors remain under-allocated to EM7. Industry flows have been significant and accelerating – there has been $47.7B of net inflows into EM equity MFs and ETFs from US investors in 2017. We believe capital flows may continue given the universal under-allocation.
Given our constructive outlook, we continue to encourage investors to build a strategic exposure to the EM asset class. However, while we see reason for optimism, we do caution investors around the limitations and risks of investing in standard EM equity indices. Specifically, the MSCI EM index only captures roughly 800 stocks out of the total 6,000+ in the investable universe. Within this already constrained universe, the index concentrates capital in structurally more impaired areas, such as state-owned enterprises (SOEs) which tend to have weak corporate governance and comprises roughly 25% of MSCI EM Index.
1. Source: Datastream, as of Dec-2017. Returns calculated using MSCI Emerging Markets index for Emerging Market equities, S&P 500 index for US equities and MSCI World index for Developed Market equities. All total returns, in USD.
2. The Taper Tantrum episode refers to the sell-off in fixed income and EM assets in 2013 due to market concerns about the potential tapering of asset purchases by the Federal Reserve.
3. Source: Factset, as of Dec-2017.
4. Return on equity (ROE) is calculated as a company’s net income as a percentage of its shareholder equity value.
5. The price-earnings (P/E) ratio is calculated as ratio of a company’s stock price to its earnings per share.
6. Source: Factset, as of Dec-2017.
7. Credit Suisse, GSAM, based on MSCI All-Country World fund manager holdings compared to MSCI All-Country index weights.
The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation.
Index Definitions
MSCI Emerging Markets (EM) Index: The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 30, 2017 the MSCI Emerging Markets Index consisted of the following 24 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. This Index offers an exhaustive representation of the Emerging markets by targeting all companies with a market capitalization within the top 85% of their investable equity universe, subject to a global minimum size requirement. It is based on the Global Investable Market Indices methodology. This series approximates the minimum possible dividend reinvestment. The dividend is reinvested after deduction of withholding tax, applying the rate to non-resident individuals who do not benefit from double taxation treaties. MSCI Barra uses withholding tax rates applicable to Luxembourg holding companies, as Luxembourg applies the highest rates.
MSCI Europe Index: The MSCI Europe Index captures large and mid cap representation across 15 Developed Markets (DM) countries in Europe. DM countries in Europe include: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK With 445 constituents, the index covers approximately 85% of the free float-adjusted market capitalization across the European Developed Markets equity universe.
MSCI Japan Index: The MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. With 320 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan.
MSCI United States of America (USA) Index: The MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. With 635 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.
MSCI World Index: The MSCI World Index is a broad global equity benchmark that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float-adjusted market capitalization in each country and MSCI World benchmark does not offer exposure to emerging markets.
S&P 500: The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
General Disclosures
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.
This material is provided at your request for informational purposes only. It is not an offer or solicitation to buy or sell any securities.
THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO.
Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant.
Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability.
Foreign securities may be more volatile than investments in U.S. securities and will be subject to a number of additional risks, including but not limited to currency fluctuations and political developments.
Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources.
Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.
Economic and market forecasts presented herein reflect our judgment as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.
References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark.
Index Benchmarks
Indices are unmanaged. The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns. Investors cannot invest directly in indices.
The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indices that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein. The exclusion of “failed” or closed hedge funds may mean that each index overstates the performance of hedge funds generally.
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Economic and market forecasts presented herein reflect our judgment as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this page and may be subject to change, they should not be construed as investment advice.
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