The first quarter for emerging market stocks can be characterized as more of the same. EM equities once again underperformed U.S. stocks, as they have consistently for the past decade. The year started with a spurt of optimism, but then the cold reality of the pandemic sobered investor spirits. Meanwhile, the U.S. surprised with competent delivery of vaccines and an extraordinary blend of fiscal largesse and monetary expansion. The combination of vaccines and stimulus convinced markets that the U.S. might achieve a rapid return to trend growth, and this triggered a strengthening of the dollar. By quarter-end it looked like the long-awaited EM recovery was on hold again, until markets begin to consider the aftermath of the the U.S. extravaganza.
For the long-term investor hoping for mean-reversion to cause cheap markets to outperform pricy ones, the first quarter was another disappointment. As the chart below shows, by and large, the least expensive markets were the worst performers for the quarter, as investors continued to focus on the reasons that made these markets cheap to begin with. Leading the way was Turkey, where Erdogan doubled up on his quarrel with economic sanity. Brazil was close behind, as Bolsonaro continued to demonstrate remarkable incompetence at managing public policy. South Africa and Chile were exceptions, both benefitting from rising prices for industrial minerals, and, at least in the case of Chile, a proficient job with delivering vaccines. On the other hand, the expensive markets all outperformed. Ironically, the two most expensive markets in the table were also the best outperformers, which is a good reminder that , over the short-to-medium term , momentum is a more powerful force than mean reversion.
Unfortunately, some of the worst performing markets may have fallen for good reasons. The pandemic and general government incompetence will have left a devastating impact on countries like Brazil, resulting in diminished growth prospects. We can see this in the chart below which shows the IMF’s latest World Economic Outlook forecasts. Few emerging market countries are expected to experience high growth, and they are all in Asia. Some of these like Indonesia, the Philippines and Malaysia also appear inexpensive in the previous chart, and therefore should be the best ponds to fish in. In Latin America, Colombia looks attractive.
Investors should focus on the inexpensive markets with good growth prospects. In addition, assuming that recent commodity price increases can be sustained, markets like Chile and South Africa may surprise to the upside. The remaining inexpensive markets — Brazil and Turkey — need some sort of a trigger (e.g. economic reform, political transition) to bring them back to life. Mexico is an interesting outlier. It is so extraordinarily well positioned in terms of the current incentives for multinational firms to near-shore production and reorganize supply chains, that even the best efforts of AMLO may not get in the way of success.