Decades of Data: Emerging Markets 1987–2022

The MSCI Emerging Markets Index geographic composition has shifted over time. Today, the Asia region dominates the index with a nearly 80% weight versus less than 50% at the index’s inception in the late 1980s. Latin America moved in the opposite direction, constituting 8% of the index today versus nearly 50% at inception. The largest countries in the Asia region—China (32%), India (14%), Taiwan (14%), and Korea (11%)—alone make up more than 70% of the broader index market capitalization. Just ten years ago, China represented only 18% of the index. Changes in index composition over time are a defining characteristic of EM as income levels rise, the corporate sector matures, and local stock exchanges open to international investors. A prime example is China, whose investable equity universe has been reshaped by the inclusion of domestically listed A-shares in benchmark indexes.

EM equities experience a wider range of returns than their DM peers. This was true over one-, five-, ten-, and 20-year trailing periods relative to DM, in both nominal and real terms, over the past 35 years. As in DM, the range of investment results for EM stocks narrows as holding periods increase. While EM equities exhibited greater potential upside over all trailing periods, they actually displayed more muted downside potential over the longer-term ten- and 20-year periods. For investors that can stomach short-term volatility, EM allocations proved fruitful in the long run, outpacing inflation.

Higher volatility results in a wider calendar-year return distribution for EM relative to DM. EM equities are more likely to deliver stellar results in any given year, having achieved 50%+ gains in six calendar years since 1988. However, negative performance occurs more frequently and with greater severity than in DM. EM declined for a second straight year in 2022, trailing DM counterparts for the fourth time in the past five years. EM and DM tend to move the same direction in any given calendar year (as was the case in 2022), with performance diverging between gains and losses in only eight of 35 years since 1988. In such years, EM typically declined while DM advanced. There has been only one calendar year across the available history when EM stocks gained and DM shares declined.

EM equity drawdowns are typically more severe than those in DM. Overall rolling five-year periods since 1992, EM experienced a deeper maximum drawdown than DM counterparts 93% of the time, coming in more than 12 percentage points (ppts) worse than the equivalent DM measure, on average. The three EM financial crises during the 1990s (the Mexican peso crisis, Asian financial crisis, and Russian financial crisis) and the 2008–09 Global Financial Crisis (GFC) produced two severe EM equity drawdowns. The COVID-19 drawdown’s magnitude was similar for EM and DM, with both segments declining roughly 34% peak-to-trough in USD terms in early 2020. Corrections, defined as a peak-to-trough sell-off of more than 10%, are common occurrences in any given five-year period for EM and DM alike.

Earnings growth is the primary contributor to EM equity total return over time. The earnings growth contribution has exceeded dividend reinvestment by 1.7x since the mid-1990s. On the other hand, valuation multiple rerating has detracted from performance overall, as the price-earnings (P/E) multiple today is lower than the mid-1990s levels. Higher dividend yields in EM translated to a higher dividend reinvestment return contribution relative to DM. But, despite the generally better growth prospects in EM (and thus the expectation of higher earnings growth), the contribution to return from earnings growth in EM lagged that of DM over the common period analyzed.

EM equities have outperformed DM counterparts since inception, but relative performance cycles span multiple years and are characterized by a high degree of performance reversion. EM stocks outperformed DM equivalents by a cumulative 300% in two outperformance cycles since 1987, which lasted roughly seven and 12 years, respectively. The 2000s commodity boom boosted earnings per share in the heavily resource-exposed EM countries, helping drive outperformance versus DM. EM has experienced a sustained drawdown vis-à-vis DM since relative performance peaked in September 2010 following the GFC, underperforming by more than 7% annualized over that time. The current period has not been as severe as the cycle ended in early 1999, which saw EM lag DM counterparts by 73% cumulative (26% annualized) in just over four years.

Starting normalized valuations are a useful guide in setting longer-term return expectations. For EM, initial valuations—such as our cyclically adjusted price-to–cash earnings ratio—exhibit a decent relationship with subsequent ten-year returns, with an R2 value of 0.46. However, the relationship weakens over shorter time horizons, with an R2 of just 0.23 versus subsequent five-year return periods. It should be noted that all normalized P/E ratios in the top decile of historical observations occurred during the 2006–08 lead-up to the GFC; other starting valuation decile ranges show a wider subsequent returns distribution.

Bear markets occur more frequently for EM stocks than they do for DM peers. Although the average bear market length and drawdown magnitude in EM and DM is roughly the same, the lifespan of bull markets in DM are about twice as long as those in EM, with roughly the same upside. EM stocks are currently mired in one of their longest bear market drawdowns on record, which started in February 2021, coinciding with China’s regulatory crackdown on the tech and real estate sectors. DM stocks didn’t enter bear market territory until nearly a year later when inflation and central bank tightening started to intensify. One common characteristic of bull markets across EM and DM is that they are, on average, longer in duration than their respective bear markets and tend to have a higher performance magnitude in absolute terms, consistent with the observation that equity markets trend upwards over time.

Inflation for EM economies runs hotter than DM counterparts, but the differential has stabilized in recent decades. High inflation plagued EM economies in the late-1980s/early-1990s period, due largely to hyperinflation in Argentina and Brazil. From 1988–95, year-over-year inflation in EM exceeded that of the United States by more than 40 ppts, on average, according to an equal-weighted basket of countries within the MSCI Emerging Markets Index. Over the past 20 years, however, EM inflation was 2.5 ppts higher than the United States, on average. The inflation differential reached 4.0 ppts in 2022, which was the largest divergence since 2009, driven by surging inflation in Turkey. However, median EM inflation in 2022 was 7.2%, based on those countries in the equity index at year-end, compared to 6.5% for the United States.

READ THE FULL REPORT