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.
So will the double bottom in relative performance of EM vs. DM show up again? I would be cautious in extrapolating from such a small sample size, but the macro puzzle pieces are slowly yet surely falling into place...
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.