Chart Of The Week: EM vs DM

This week we’re looking at EM (emerging) vs. DM (developed markets) relative performance. Emerging market equities have come under pressure recently as a stronger US dollar, Fed tightening, and political risk have come into focus.

The chart comes from a report on emerging market equities in which we consider the short-term vs. medium-/longer-term outlook.

The chart shows the long-term view of relative performance between EM and DM and there’s a noticeable pattern that seems to be playing out again.

Specifically, the chart shows the MSCI Emerging Markets Index as a ratio against the MSCI Developed Markets Index (both in USD terms, and rebased to 1 at the starting point in 1988). When EM began its relative bull market of the mid-2000s, it underwent a long-term ‘double bottom’ process as a number of macro puzzle pieces slowly fell into place.

Back then, EM underwent a period of stress before recovering and then enduring a global recession. Through this process, valuations were made cheap on a relative and absolute basis, and likewise the currencies saw a significant devaluation which presented an ideal starting point from a value investing standpoint.

As we look at it now, EM underwent a recession in 2015/16, and is undergoing a period of stress right now due to stronger US dollar, Fed tightening, softer growth in China, and political risk. Already valuations in EM are materially cheaper vs. DM, and the recent selloff has brought absolute valuations back down to earth – not wildly cheap, but certainly no longer expensive. So the pieces are falling into place. My only concern is that it feels like there may be more to come on the EM stress front as the US dollar could easily strengthen further from here and the Fed continues to tighten.