Emerging Markets Have An Earnings Problem

The past decade has been a disaster for investors in emerging markets because nominal earnings measured in dollars have not grown.

There are several reasons for this earnings stall:

First, the past 11 years have been a period of dollar appreciation. Due to its broad global use in invoicing and financing commercial flows, a strengthening dollar has had a depressing impact on most developing countries. Moreover, as typically occurs, a strong dollar has meant weak commodity prices and poor results for commodity producers (Latin America, Russia, South Africa, etc.).

Second, the fall in earnings and investor returns can be seen as a bearish cyclical adjustment after the prior decade of plenty. The weak dollar and commodity boom of the 2002-2012 decade provided outsized results for emerging markets, which were given back over the next ten years.

Third, profitless China has weighed down the asset class. China’s capital-intensive state-run economy has resulted in very low returns on capital and persistent dilution of investors in the stock market. This was a minor issue in 2000 when China was only a small part of the EM stock indices but became a huge burden over the past decade when Chinese stocks came to dominate the indices. The brief tech boom in China (e.g., Alibaba, Tencent, massive foreign private equity inflows) changed the perceptions of investors until it was crashed by Xi’s crackdown on the companies for their “socially destructive” behavior.

The following charts illustrate the evolution of nominal dollarized earnings over time for emerging market stocks. The first chart shows earnings data for the primary EM countries and the S&P 500 during the modern era heralded by the introduction of the MSCI EM index in 1986, including estimates for 2024. Over this long period, Mexico leads by a considerable margin, while India and Taiwan are neck-and-neck with the S&P 500. Before the S&P 500’s recent spurt (2020-2023), earnings growth in EM was broadly in line with the S&P 500.

The next chart shows earnings data starting in 1992 when China was included in the MSCI EM Index. Remarkably, China’s earnings in 2023 are below the level of 1992. Brazil leads the pack over this period, with the characteristic extreme cyclicality of commodity dependence, surging during the commodity supercycle (2002-2012), tanking during the commodity collapse (2012-2016), and recovering with the bounce in commodity prices starting in 2016. India stands out as the star performer over this period, as it has provided high earnings growth without the volatility of commodity producers. Also, unlike the capital-intensive, export-oriented businesses of China, Korea, and Taiwan, India’s mogul-controlled corporates enjoy strong market power, allowing for high and consistent returns. The S&P 500 experienced enormous volatility over this period marked by the combination of financialization of the Information and Communications Technology (ICT) cycle and monetary adventurism: two bubbles (tech, 1999-2001; real estate, 2003-2007), followed by crashes; an increasingly activist Federal Reserve, resulting in 15 years of negative real interest rates. Nevertheless, the enormously profitable tech giants supported the S&P 500.

The last chart shows the period after the Great Financial Crisis (GFC), 2010-2024. The post-GFC is characterized by “secular stagnation,” a period of low growth and low inflation which was met by the Federal Reserve with policies last seen in the Great Depression of the 1930s: massive money printing, negative interest rates (financial repression), and increasingly large interventions to support asset prices. This period also saw a persistent appreciation of the USD. The clear leader over this period has been the S&P 500, propelled not only by the rising USD but also by the remarkable expansion of profit margins for the monopolistic tech giants (FAANG) which saw profit margins rise from around 10% to the current 25%. Since 2019, earnings in both Taiwan and Mexico have recovered because of stellar results from TSMC in the former and a strengthening of the peso in the latter. Weighed down by China, EM nominal earnings have fallen over this long period. These years have been equally bad for commodity producers (low prices) and East Asian exporters (rising operating and financing costs and brutal competition from China). Even India, with its high GDP growth and booming asset prices, has seen no earnings growth over this period.