The Changing Dynamics of Emerging Markets’ Economies

by: Richard A. Anderson

The MSCI Emerging Markets Index looks significantly different today than it did at its inception thirty years ago. For one, the market capitalization of emerging markets companies has increased from $52 billion in 1988 to $5.3 trillion as of May 31, 2018. This underscores the ability of emerging markets countries to contribute to the global economy, especially as global markets have expanded.

Over time, the forces driving emerging markets economic growth have changed. In the past, stock market performance and commodity prices tended to move in tandem across many emerging market countries. This was because commodity extraction and exportation played a major role in many emerging markets countries’ economies.

In recent years, however, many emerging markets countries have moved away from dependence on commodities and exports. This changing dynamic is clear when looking at the chart below, which shows the top sector weightings in the MSCI Emerging Markets Index on June 30, 2007 and June 30, 2018. Back in 2007, the materials and energy sectors of the MSCI Emerging Markets Index combined to represent 32% of the index. Information technology and consumer discretionary represented only 12% and 5% of the index respectively.

Eleven years later, the sector weightings look drastically different. The information technology sector now represents 29% of the index, which is an increase of nearly 250%. The consumer discretionary sector has also nearly doubled over this time period, now accounting for 9% of the index. Meanwhile, the materials and energy sectors of the index now combine to represent 15% of the index, which is less than half of the 2007 total.

08202018_MSCI Emerging Markets Sector Weightings.png

The changing shape of long-term economic growth in emerging markets is best exemplified by China and India. The Chinese and Indian economies have seen significant growth in financial services, e-commerce, and technology, spurred by an increasingly affluent middle class, developing technological infrastructure, and growing private sector.

What does this mean for you? We have always maintained an allocation to emerging markets equities because of their potential for long-term growth and diversification benefits. As an investor in emerging markets stocks, these structural changes present new investment opportunities as the share of global GDP increases for emerging markets countries.

But it also highlights that using the past as a proxy for the future is a dangerous investment strategy. The risk and return profile of emerging markets in the past has been driven by the price of commodities and U.S. monetary policy. Given the structural changes to emerging markets’ economies, we can’t expect emerging markets stocks to follow the same pattern of behavior as in the past. This further strengthens our belief in having a long-term strategic asset allocation rather than attempting to time the market by waiting for a buy/sell signal. After all, the signals of the past may not work anymore.