To the shock of many, MSCI Rising Markets Index returns in 2020 matched these of the S&P 500. Given this robust efficiency, are there causes to be optimistic about rising markets in 2021? Certainly, there’s a lot to love about their elementary outlook, and affected person traders may benefit from a robust rebound in earnings. That being mentioned, there are near-term dangers to be aware of: the robust snapback in 2020 implies that rising market equities shouldn’t have the wind of extraordinarily low cost valuations behind them. Plus, they proceed to face challenges, with potential restrictions arising from the unfold of recent coronavirus variants and rising U.S. rates of interest.

A Look Again at 2020

Early in 2020, traders fled rising markets for the protected haven of the U.S. greenback and dollar-denominated belongings. Their nervousness was comprehensible. When the COVID-19 pandemic hit, rising market international locations didn’t have superior well being care infrastructures, they didn’t have cash to spend, they usually couldn’t afford to print cash like many of the developed world. In different phrases, they have been shedding a grip on their future. However many rising markets did a better-than-expected job of managing the pandemic, and the resilience of their economies was mirrored of their inventory markets.

The place Will Rising Markets Go Subsequent?

As we glance forward, there are 4 key catalysts for rising market fairness returns: enchancment in well being outcomes, international development alternatives, the power to fireside on all cylinders, and greenback depreciation.

Enchancment in well being outcomes. There was a stark divergence within the success charges of rising market international locations in dealing with the pandemic. China and several other different North Asian international locations navigated the disaster significantly better than the remainder of the world, whereas many Latin American international locations struggled. Even now, there’s extensive dispersion within the penetration of the vaccination applications. Thus, economies of some international locations have rebounded faster after the sharp collapse early final yr, and others are on the tail finish of the disaster. As vaccinations get underway, we may see better optimistic convergence amongst rising international locations, because the North Asian economies maintain optimistic momentum whereas others reopen and rebound.

World development alternatives. Rising market international locations have a better beta to international development. Following the preliminary lockdown, international manufacturing development rebounded strongly and remained resilient through the subsequent virus waves. Industrial manufacturing volumes are above pre-crisis ranges in most rising markets. General, rising market international locations weathered the pandemic higher than developed international locations and are anticipated to steer the restoration within the post-pandemic interval.

Capacity to fireside on all cylinders. Prior to now couple of a long time, the rising market index has pivoted from an chubby in conventional supplies, power, and financials to extra growth-oriented sectors like know-how, shopper discretionary, and well being care (see chart under). Secular tendencies like digitalization and elevated spending on well being care, logistics, and premium merchandise ought to proceed because the pandemic disaster strikes behind us. The evolution of the sector make-up of the rising market index is favorable for higher earnings development charges and performs into the long-term rising market shopper theme.

There’s additionally the prospect for broadening of the rising market alternative set. The latest surge in commodity and oil costs has lifted optimism about financial prospects within the massive pure useful resource producers in Latin America and the Center East. Whereas this will not sign the beginning of one other commodity tremendous cycle, it does increase the near-term outlook for the cyclical areas and sectors of rising markets.

Greenback depreciation. Rising market equities are likely to do higher in a weaker greenback surroundings. A weaker greenback results in simpler monetary situations and attracts overseas capital into rising markets. Conversely, because the greenback strengthens, rising markets expertise outflows and weaker returns for U.S. traders. The greenback has been range-bound up to now few months, as longer-dated U.S. charges rose, and there’s potential for some strengthening right here if the upward stress in charges stays. However the elementary elements for a longer-term development of a weaker greenback proceed—huge cash printing, an enormous fiscal deficit, and broadening international development. A weaker greenback may carry rising market equities additional.

Evaluating the Close to-Time period Threat

After robust positive factors in latest months, rising market equities seem to have come off the boil, pushed partially by rising U.S. Treasury yields. Regardless of the latest declines, valuations in components of rising market equities look stretched relative to their historical past (see chart under). This might show to be a near-term headwind, particularly if U.S. charges proceed to rise and the greenback consolidates positive factors or rises additional.

Supply: Capital Economics

Earnings Development Forward?

Whereas richer valuations may very well be a headwind, stronger earnings development may carry the day (or yr) for rising markets. Valuation modifications have been the important thing driver of rising market fairness returns up to now few years. Even in 2020, when earnings of rising market firms tanked as international locations went into lockdown, investor sentiment and, therefore, valuation multiples rebounded shortly.

Going into 2021, a lot of the heavy lifting will should be executed by earnings development. Right here, the outlook is kind of sturdy. Consensus expectations are for a virtually 30 % rebound in company earnings. Regardless of the richer multiples relative to historical past, there’s a better probability that rising market equities will develop into these valuations and reward traders via greater earnings development.

Supply: Goldman Sachs Asset Administration

The Lengthy View

Rising markets provide engaging development alternatives, each now and over the long run. They’ve survived a number of stress checks over time, and their efficiency through the pandemic is but extra proof of their resilience. Trying forward, I count on sturdy danger urge for food to assist rising market belongings. Submit-pandemic restoration of home economies, accelerating international development, and a weak greenback—these are only a handful of the various elements supporting an publicity to rising markets.

That mentioned, valuations of rising market equities look wealthy on a historic foundation, with the MSCI Rising Markets Index’s ahead price-to-earnings ratio buying and selling at 16x, versus a five-year common nearer to 12x. Features in 2020 got here from a number of expansions, as is the norm when exiting recessions. Going ahead, earnings per share development from a synchronized international financial restoration will drive fairness costs. This might result in a broadening of positive factors to the extra cyclically oriented areas and sectors of rising markets that lagged the latest rally and provide extra engaging valuations.

Editor’s Word: The  unique model of this text appeared on the Unbiased Market Observer.