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Emerging Markets: Recent pause cause for alarm?

INSIGHT ARTICLE  | 

After bottoming in March of 2020, emerging markets (EM) stocks rallied alongside their U.S. and foreign developed counterparts over the balance of the year. The development of multiple COVID-19 vaccinations, coupled with coordinated fiscal and monetary support, led investors (and the public at large) to anticipate a gradual return to normalcy that would prompt consumers around the world take postponed vacations, dine out, and enjoy a host of other activities they had foregone amid the pandemic. Those expectations triggered a global stock market rally.

Though many EM countries lacked the ability to provide fiscal stimulus to the extent of the U.S. and Europe, strong performance was underpinned by a surge in commodity prices expected to provide an outsized benefit to those mostly export-oriented economies. Further, massive fiscal and monetary stimulus in the U.S. helped to put downward pressure on the dollar, adding to domestic investors’ returns.

Turn the page to 2021, and that emerging markets trend has abated somewhat. The U.S. dollar has flatlined, removing the tailwind U.S. investors experienced last year. More importantly, a slower-than-expected vaccination rollout in emerging economies, the emergence of COVID-19 variants, and a resumption of lockdowns in some countries has caused investors to reassess their near-term outlook. Further, surging commodity prices — a boon to EM countries in 2020 — has spurred outsized inflation in food and energy prices that has prompted nine rate hikes among EM central banks in March in April. While higher interest rates attract capital, which can lead to higher long-term economic growth, they also can put downward pressure on equity prices in the near term.

Still, as those countries catch up in the race to herd immunity, a more global cyclical recovery can begin in earnest, which could provide an outsized benefit to the asset class. Performance over the balance of the year may be choppy, but we recommend investors stay the course with their EM allocations. The continually improving economic outlook bodes quite well, and consider that EM stocks have historically witnessed multi-year patterns of outperformance. Since 2000, EM has tended to be the best (or near-best) performing asset class in the years following market shocks (post-dot com bubble [2003-07], post Financial Crisis [2009-12]).

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