5 Things to Know About Emerging Markets Equities

The insights in this article are from the Goldman Sachs Wealth Management Investment Strategy Group’s In Brief published July 25, 2023. 

Emerging markets (EM) have underperformed most other major equity markets for some time. The MSCI EM equity index is currently in its third worst ‘relative bear market,’ defined as an episode where the MSCI EM underperforms the S&P 500 by 20% or more. This episode has lasted for more than 32 months — much longer than the 13-month median for previous relative bear market episodes. Furthermore, the MSCI EM index has underperformed the S&P 500 by 46%, its third-worst relative return compared with historical episodes.

We delve into some key insights about emerging markets from the Goldman Sachs Wealth Management Investment Strategy Group (ISG).

EM bear markets are more frequent. Over the last three decades, EM equities have experienced 13 declines of 20% or more, compared with five for the S&P 500, and have spent double the time in a bear market.

Faster economic growth in EM doesn’t mean better equity market returns. A big misconception about investing in EM assets is the view that faster economic growth will result in higher equity market returns compared to developed markets. The data shows this doesn’t pan out. Over the last 30 years, EM GDP grew faster than U.S. GDP 93% of the time, yet EM earnings grew faster than U.S. earnings only 37% of the time.

Declining EM earnings are driving underperformance. The key driver behind EM equities current underperformance relative to the U.S. is the sharp deterioration in relative earnings, with the MSCI EM forward earnings per share (EPS) estimates lagging those of the S&P by 44%. Over a longer-term horizon, U.S. equities outperformance over EM is also explained by differences in earnings growth. Due to lower earnings growth, annualized total returns for EM equities have consistently trailed behind the U.S., with the gap in EPS growth widening over the years (1.6 percentage points annualized over the last 30 years, compared to 9.4 percentage points over the last five years).

EM earnings are expected to decrease further. There is a close historical relationship between changes in MSCI EM forward earnings and EM exports. ISG expects weaker export growth than consensus, given below-trend global growth and lower commodity and semiconductor prices. As a result, their 2024 MSCI EM EPS forecast of $80 is also below consensus. In contrast, ISG remains constructive on the upward trajectory of S&P 500 earnings, including expectations for mid-single-digit growth this year.

Investment view: An underweight allocation to EM equities is warranted, according to ISG, given the points outlined above. The allocation to EM equities in ISG moderate model portfolios is only 3% of the overall public equity allocation. This allocation helps diversify portfolios. Despite EM equities underperforming U.S. equities since the inception of MSCI EM, there have been many episodes where MSCI EM outperformed the S&P 500 over shorter periods of time.

The data in this article is accurate as of October 9, 2023.