THE MARKETS THAT NEVER EMERGE / THE WALL STREET JOURNAL

The Markets That Never Emerge

Emerging-market stocks have had a miserable decade. The slowdown in Chinese growth suggests they won’t break out as the next one begins.

By Mike Bird


The outlook for emerging-market stocks is now clouded by the growth outlook in China. Photo: roman pilipey/Shutterstock


After 10 years of misery for emerging-market stocks, investors may want to think about another name for the asset class.

Equities from outside the world’s advanced economies haven’t emerged into anything, and the prospects heading into a new decade don’t look any better.

The benchmark MSCIEM Index has offered a total return of 47% in dollar terms since the end of 2009, compared with 159% for the MSCI World Index, which tracks developed-market stocks even if its name suggests otherwise.

That isn’t just because the U.S. has done so well.

The MSCI Japan index has returned 95%. Stocks in Europe were slammed by the sovereign debt crisis and a feeble economic expansion, but investors would still have been better off buying into the old world than emerging markets.

Telling investors at the beginning of 2010 that the market’s performance would be so miserable might have been a hard sell.

Supported by massive Chinese stimulus, the MSCI EM had just recovered the lion’s share of its financial-crisis losses and returned more than 150% for the first decade of the 21st century.

U.S. markets lost investors money over the same period.

The outlook for emerging-market stocks is now clouded for exactly the same reason that they rallied back from the financial crisis so quickly: Chinese stimulus and credit policies matter more than anything else to the index.

With the Chinese government now increasingly fretful about debt-driven growth, a prolonged slowdown seems all but inevitable.

What is more, the makeup of the index has changed considerably: China’s direct share in it has roughly doubled from one sixth to one third, and that now includes stocks listed in the mainland.

Even that understates the country’s weight in the asset class, since other Asian economies are far more heavily exposed to China than they were 10 years ago.

While the lower underlying profitability of listed companies in developed markets, as measured by their return on assets, has crept back up toward its level before the financial crisis, the metric has tumbled in emerging markets, closing the gap between the two considerably.

That means investors are no longer compensated for the sector’s higher volatility.

The cause of the decline is largely slowing growth, and with debt levels already elevated the companies cannot safely compensate by levering up.

As for valuation, earnings multiples suggest emerging-market stocks are cheap relative to their developed world peers, with a 12-month forward price-to-earnings ratio of around 12.3, compared with 16 for stocks globally.

But that sort of gap has existed for much of the index’s history.

It is hard to imagine any source of growth large enough to offset the slowdown in the world’s second-largest economy.

Emerging market stocks are set to start a new decade facing the same problems that plagued them in the last one.