Are Emerging Markets set for a turn from a decadal low tide?

It had been a dry run for emerging markets (EM) for a decade. It may come as a surprise to many that the emerging engines did not do much for the ten-year period ending December 2021. To be precise, MSCI EM index delivered a near-flattish annualized returns of 3% over that period. By contrast, in the same period, US markets (S&P) delivered a stunning outperformance by giving annualized returns of 14.2% in the same period. As happened in most decades in the past, whenever US markets outperformed by a significant margin, it always came at the expense of emerging markets. Last decade was no exception. At the same breath, reverse has also been true for many decades. That is, whenever US markets struggled with sub-par returns, those decades belonged to emerging markets. Are we in for such a turn now for emerging markets? Let us find out.

To make the case for emerging markets, let us first look at certain key historical data points in terms of how US and EMs have done in terms of returns in the last decade. For US, last decade was a stellar one in terms of returns. S&P delivered annualized returns of over 16.6% (14.2% excluding dividends) in this period. No complaints. On the other hand, emerging markets, as measured by MSCI EM index, delivered paltry returns of 3% (without dividends) annualized over the same period. It was such a striking and stark difference that made them two different worlds at either end of the spectrum in the investment universe. More interesting data emerges if one breaks down the S&P returns data in terms of contributions from sales growth, margin expansion and multiple gains. Here, let us use data from the recent study done by Christopher Bloomstran in his recent annual letter (as captured brilliantly by Akash Prakash (Amansa Capital) in his latest piece).  As per this, the overall return of 16.6% is made up of 3.8% sales growth, 4% margin expansion, 6.4% multiple expansion and finally 2.4% of dividend yield. This letter argues that, looking ahead into the next decade, even if one assumes that sales growth continues at 3% level, it is less likely that any gains will come from margin expansion or multiple gains, given that they are at more than peak on a cyclically adjusted basis. Adding another 2% growth from dividend yield, it projects a bleak prospects for the S&P annualized returns of near 5% in the coming decade. Taking it further, as a corollary, this would also mean that the emerging markets would shine brighter with a big outperformance in the next decade. This assumption is supported by the historical data points.

Now coming to India, in addition to this expected turn in favor of EMs, what will make the medium/long term outlook more compelling bull case is the huge tailwinds it is likely to get from the larger trends that are brewing globally. Borrowing from Morgan Stanley’s recent research note, larger global trends like Decarbonization, Deglobalization and Digitization are likely to disproportionately benefit India compared to any other country. It is difficult to spot any other country that will get a boost from all of these trends. While China+1 and Europe+1 are central to deglobalization, India’s push in green energy and hydrogen initiative is likely to invigorate the revival in private capex cycle. In digitization, though it covers a big scope and large spectrum, if one specifically limits the focus to offshoring potential on India becoming office to the world, the prospects seem extremely bright, esp. with work-from-anywhere trend gathering traction across global corporations. Of course, all these will not happen overnight, but will evolve over time.

In addition to above, India’s macro is also likely to gain momentum from the other cyclical trends listed below.

  • Cumulative low base effect of slow growth for many years.
  • Turn in property cycle having a multiplier effect on the economy.
  • Revival in Private Investment Demand.
  • Credit cycle turning in India on the back of clean-up of bank and corporate balance sheets.

Going by market actions in EMs and in India in particular over this down cycle, looks like, global investors are positioning themselves for leadership from these market segments in the next upcycle.  As is well known, in markets, if a sector falls much less in a down turn or if a sector demonstrates a lot of resilience in a falling market, then such sectors lead in the following bull market. If one extends the same logic to the EM basket or to specific markets within the EM, going by India’s convincing out-performance in the current down cycle, it will not be a surprise if India leads the next bull cycle within the emerging market basket which in all likelihood will out-shine markets like US where the returns are likely to sub-par in the next decade, as argued in the opening section of this article. It is time for EMs to carry the baton!

This article of mine was published in the online edition of Economic Times (04/12/2022). Glad to share the link:


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