Roughly 160 of the world’s nearly 200 countries are considered emerging markets (EM), and approximately 6 billion people, or 85% of the world’s population, live in emerging economies (map, below). Thus, there are plenty of reasons not to ignore emerging markets in a portfolio. But there are special considerations unique to emerging markets. These include currency movements, different political and legal systems, greater exposure to commodity prices in some cases, and periodic debt troubles. However, none of this is new, and many emerging markets are evolving from immature, rapid growth toward more mature, slower growth. Even though growth may be slowing in the EM and unique risks exist, we should still consider EM opportunities because these markets appear to offer better value than developed markets (DM) now and because emerging markets appear well-positioned to capitalize on a rebounding global economy post-COVID-19.

Emerging Markets

Emerging = Blue
Developed = Grey

Converging Growth

It is crucial to understand that the EM, while still growing faster than the developed world, is no longer growing as it once did. The chart below shows how EM is converging toward lower DM growth rates (Chart A, below). The largest two contributors to the EM downshift are productivity and labor. According to the Conference Board, EM productivity growth fell to -0.5% in 2019 from 1.5% average growth between 2000-2007. At the same time, labor growth slowed to 0.3% in 2019 from 0.8% in 2000-2007. Taken together, slower growth in productivity and labor is bringing EM growth rates closer to those of mature economies.

Better Value?

Even though EM growth may be slowing, we should consider EM opportunities because they seem to offer better value. To see why, we can look at the total value of a market’s stocks, plus net debt, versus sales. This ratio is called an “enterprise value to sales” (EV/Sales) ratio. It is a broad measure of value that considers both creditor and equity owner interests as providers of capital.

The US stock market has had an EV/Sales ratio between 1.5-3X for most of the past 25 years. Today the S&P 500, proxy for the US stock market, trades near the top end of that range. By contrast, the emerging market EV/Sales ratio ranged between 1-2.5x for the past 25 years. Today, the EV/Sales ratio for the EM is near 2x, easily inside the historical range (Chart B, below). All else equal, a better starting valuation is positive for future returns.

Chart B
Comparing Valuations (EM vs. Domestic Stocks)

Positioned for Growth Rebound

Emerging markets are far more sensitive to upturns in the global business cycle. The greater sensitivity is because a large share of EM economies is based on producing goods and raw materials. By contrast, developed economies tend to focus on less cyclical services. When global surveys of manufacturing activity turn down or up, EM stocks tend to respond. If the worldwide outlook for growth continues to make progress and COVID-19 worries begin to fade, growth should pick up, providing a powerful tailwind for emerging markets. Our analysis of incoming data suggests that growth continues to improve based on the most recent update of our WCA Barometer (Chart C, below).

Chart C
WCA Conditions Barometer

While we cannot know with certainty how the next few months will pan out, existing data point patterns to continued recovery. It is also worth noting that EM versus DM equity markets’ relative performance is starting to show signs of lift (Chart D, below).

Chart D
Emerging vs. Developed Market Relative Performance


So although growth rates between emerging and developing economies seem to be converging, we should position portfolios for better emerging market performance for two main reasons now. First, emerging markets appear to offer better relative value than developed markets. Most importantly, EM is well-positioned to benefit if global growth continues to pick up, especially if COVID-19 worries fade.

Could the case for emerging markets come undone? Of course, it could. Yet, the stars appear to be aligning for potential outperformance in the months ahead. We will continue to track and challenge our key assumptions underlying our bullish tactical case for EM. But so long as we continue to see progress in critical areas of the global economy, the case for EM is likely to remain intact.

Kevin R. Caron, CFA
Senior Portfolio Manager

Chad Morganlander
Senior Portfolio Manager

Matthew Battipaglia
Portfolio Manager

Steve Lerit, CFA
Senior Risk Manager

Paul Clark, CFA
Senior Portfolio Manager
Municipal Fixed Income

Rick Marrone
Senior Portfolio Manager
Municipal Fixed Income

Suzanne Ashley
Internal Relationship Manager

Eric Needham
Director, External Sales and Marketing

Jeffrey Battipaglia
External Sales and Marketing


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