Emerging markets diverge from playbook

For investors in emerging markets, the playbook has been a familiar one for decades: when commodities prices go up, so do emerging market stocks and vice versa.

The logic is simple: the emerging world is where (most) commodities come from. If you are bullish or bearish on global growth, you feel the same about commodities and EM stocks.

But this year the narrative has changed. As a post-coronavirus recovery became visible late last year, both sets of assets surged. Between early November and late January, the S&P GSCI commodity index and the MSCI Emerging Markets equity index each gained about 25 per cent.

Since then, commodity prices have risen another 30 per cent, while EM stocks have flatlined.

One simple explanation is that there is less reason than there used to be for EM stocks and commodities to rise and fall together. The days when the MSCI EM index was dominated by commodity producers in Latin America are long gone. Today, companies in China, Taiwan, South Korea and India make up three-quarters of the index.

Tech, in particular, dominates. Information technology stocks are 20 per cent of the MSCI benchmark. However, Daniel Salter of Renaissance Capital, an EM and frontier market equity specialist, says their true weight is almost twice that much.

By his calculations, including tech companies in sectors such as communications services and consumer discretionary, tech stocks make up 38 per cent of the index. That compares with less than 5 per cent for energy stocks and 9 per cent for materials.

Nevertheless, commodities and EM stocks have continued, until recently, to move in tandem. That may simply be a reflection of investors’ appetite for risk. But there are real world reasons, too.

Often, the driver for both sets of assets has been China. The country’s resilience to the pandemic — it was the only major economy to register growth in 2020 — might suggest this narrative was still alive. But concerns over shaky finances in parts of the Chinese economy have once again showed up on investors’ radars. Beijing has increased its scrutiny of the country’s $17tn credit market, making financial stability once again the priority over economic growth.

With the world’s second-biggest economy unlikely to power ahead as before, the impetus behind both commodity prices and EM stocks has slowed. Thankfully for commodity producers, the US and President Joe Biden’s stimulus spending has stepped in to keep demand on the boil.

“A Chinese slowdown would normally be reflected in softer commodity prices,” said Ian Beattie, fund manager at Nedgroup Investments. “But there has been an offsetting boost from the Biden stimulus package and the economic reopening in the US and Europe.”

A global recovery led by the US and Europe should be good for EM exporters in general. But that prospect is undermined by the associated threat of inflation and rising interest rates.

“You can tell a really positive macro story, with the opening of the global economy, a return of tourism, the potential for a new commodity boom,” said Mary-Therese Barton, head of emerging debt at Pictet Asset Management. “But on the other hand, we would probably struggle to find a strong structural growth story.”

She described markets as overshadowed by uncertainty, which had been exacerbated by data surprises from the US on employment and inflation. “Everyone is expecting surprises,” she said. “But how can we make forecasts when we get this scale of outsized surprises on US data?”

She is not alone in expecting a bumpy ride ahead. Simon Quijano-Evans of Gemcorp Capital, a longtime EM specialist, said investors had been thrown by the quantity of economic data surprises and the confusion caused by unprecedented comparisons with a low base last year.

Many are also coming to terms with the completely new experience of rising inflation — at least for those not familiar with the boom and bust ride of EMs.

Investors in developed countries, Quijano-Evans said, appear ready to put the pandemic behind them. But the global picture is still uneven, with coronavirus case numbers still high in parts of South America and the possibility of new variants a continuing danger until the global vaccine rollout matches that of the rich world. The decoupling of commodities and EM stocks, he said, was a pre-taste of what is to come.

“I am pretty sure there are going to be a lot of surprises that we are not thinking about now because we have not been faced with this situation before,” he said. “Many of us thought 2021 was going to be easier than 2020. But dealing with the spillover effects of Covid-19 in the real economy will last at least into 2022.”

jonathan.wheatley@ft.com