Emerging markets have once again decoupled from the West. The last time they did so, in 2007, it ended in tears. Will this time be different?
First, the facts. The MSCI US Index is up 5.4% this year and the MSCI World Index up 8%, while the Emerging Markets Index has gained 39%. MSCI India is up an astonishing 66%. The chart gives you the details.
One argument could be that this isn’t decoupling at all, but merely the result of the well-known fact that India and China are high beta markets.
Money rushing into relatively illiquid emerging markets makes them go up faster during booms and makes them fall harder during busts. But this time, the money has been deserting developed markets and heading straight for emerging market stocks.
Fund tracker EPFR Global says, “Flows into all emerging market equity funds since the second week of March now total $30.3 billion (Rs1.44 trillion), compared with collective net outflows of $11.8 billion posted by developed market equity funds (those of the US, Europe and Japan).
“The emerging market equity funds year-to-date have now taken in $29.5 billion of inflows, while developed market equity funds have seen outflows of $51.6 billion.”
The chart shows the surge in MSCI Index of the different markets. Ahmed Raza Khan / Mint
Could it be the result of higher risk appetite? Of course risk appetite is necessary, but surely investors can be excused from rushing into countries that show decent growth when the developed world is in a deep recession?
Perhaps the way to describe the rush of funds to emerging markets is not the revival of risk appetite but a flight “from risk”. Growth may be lower in emerging markets than earlier, but at least they do not have collapsing banks and their consumers are not saddled with a massive debt burden.
But it’s only when you compare returns over the longer term that you begin to suspect that there could be something to the decoupling thesis. As the chart shows, while emerging markets, and particularly India and Brazil, have shown very decent returns over the last three, five and 10 years, the US and the UK markets and indeed the MSCI World Index have all shown negative returns.
No wonder the talk of a lost decade for stocks in the US media is a bit lost on emerging market investors.
Nor are these returns high because emerging markets have bounced back recently. If we take the MSCI indices on 31 October, at the end of an extremely bad period for equities, particularly emerging market equities, the results are revealing.
While the MSCI Emerging Market Index was down 54% year to date on 31 October, much worse than the 34% fall in the MSCI US Index, the longer-term numbers continued to show much better returns for emerging markets. For example, the three-year annualized return for the MSCI EM Index as on 31 October was -2.6%, the five-year annualized return was 6.9% and the 10-year annualized return was 7.3%. In sharp contrast, the three-year return for MSCI US was -7%, five-year -1.5% and 10-year -1.5%.
The big question, of course, is whether the rush of money into emerging market equities is sustainable. We all know how the last rush ended in 2007 and early 2008. But it’s very likely that the long-term trend of outperformance by emerging markets reflects an underlying change in the world economy with emerging markets such as India and China coming into their own. What if 2007 was not an aberration and the abnormal year was actually 2008?
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