Emerging Markets: Underperformance Amid Strong Dollar and External Factors

December 30, 2024

In recent years, the performance of emerging markets has been a mixed bag, with many investors grappling with the uncertainty of their returns against a backdrop of an increasingly strong dollar. Over the last decade, proponents of investing in these regions have had to confront the persistent underperformance of emerging markets when compared to their developed counterparts. The MSCI Emerging Markets Index, a benchmark used to measure performance in these regions, has gained only a modest 3.7% annually. This is starkly contrasted by the MSCI World Index’s gain of 9.1% per year and the MSCI World ex USA’s 4.7%. Even with a positive uptick in 2024, with emerging markets showing gains of 13%, they still lag behind the MSCI World, which has surged by an impressive 22% during the same period.

Diverse Performance Across Emerging Markets

Several countries within the emerging markets have showcased varied performance trends. Both India and China have demonstrated returns of 19%, which can be attributed to significant policy changes and forward-looking growth prospects. Taiwan has outperformed most emerging markets by a substantial margin, experiencing a 41% surge, primarily due to the remarkable performance of TSMC (Taiwan Semiconductor Manufacturing Company), a major chipmaker that accounts for half of Taiwan’s index.

In contrast, other markets have not fared as well. South Korea, for instance, experienced a 12.5% drop in local terms, primarily because of Samsung Electronics’ staggering 30% slump. Brazil and Mexico have also faced declines, driven by domestic economic challenges and concerns regarding political stability. These disparities illustrate the granularity and complexity inherent in emerging markets, where individual country performance can vary dramatically based on economic and political factors.

Middle Eastern markets have also faced headwinds, with performance hindered by weaker oil prices. Southeast Asia, excluding Singapore, has remained largely underwhelming, unable to rally the same level of investor confidence observed in other regions. This disparity is further emphasized when considering individual stock performance and the broader impact of external economic factors, showcasing the unique challenges and opportunities present in different emerging markets.

Economic Factors and Investment Potential

Despite many emerging markets underperforming, a broad consensus suggests these regions are still relatively affordable. This is indicated by a forecasted price-to-earnings ratio of 12, except for higher valuations in India and Taiwan. For these markets to achieve broader and sustained growth, supportive external factors are crucial. Historically, a weaker dollar has boosted emerging markets’ performance. However, this condition hasn’t been prevalent lately, leaving a vital growth catalyst absent.

With the possibility of US stocks overheating, emerging markets might become a valuable contrarian investment opportunity for savvy investors looking to diversify. This perspective depends on the expectation that economic conditions will eventually favor emerging markets, leading to a potential re-rating of their valuations.

In summary, while emerging markets show potential through significant individual market growths, they generally lag due to broader economic challenges, political instability, and specific country issues. However, they remain affordable investment options. If favorable economic conditions like a weaker dollar arise, substantial growth might follow. The analysis of emerging markets’ recent performance underscores the importance of considering external economic influences and individual market conditions when evaluating investment opportunities in these regions.

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