For investors in emerging markets, the playbook has been a familiar one for decades: when commodities prices go up, so do emerging markets stocks – and vice versa.
The logic is simple: the emerging world is where (most) commodities come from. If you’re bullish or bearish on global growth, you feel the same about commodities and emerging markets 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 emerging markets stocks have flatlined.
One simple explanation is that there’s less reason than there used to be for emerging markets stocks and commodities to rise and fall together. The days when commodities producers in Latin America dominated the MSCI Emerging Markets index are long gone. Today, companies in China, Taiwan, South Korea and India make up three-quarters of the index.
Technology, in particular, dominates. Information technology stocks are 20 per cent of the MSCI benchmark. However, Daniel Salter of Renaissance Capital, an emerging markets and frontier markets equity specialist, says their true weight is almost twice that much.
By his calculations, tech stocks, including tech companies in sectors such as communications services and consumer discretionary, 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 emerging markets 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, China has been the driver for both sets of assets. 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 China’s economy have once again showed up on investors’ radars. Beijing has increased its scrutiny of the country’s US$17-trillion 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 emerging markets stocks has slowed. Thankfully for commodity producers, the U.S. 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,” says 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 U.S. and Europe.”
A global recovery led by the U.S. and Europe should be good for emerging-markets 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,” says 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 describes markets as overshadowed by uncertainty, which was exacerbated by data surprises from the U.S. on employment and inflation.
“Everyone is expecting surprises,” she says. “But how can we make forecasts when we get this scale of outsized surprises on US data?”
She’s not alone in expecting a bumpy ride ahead. Simon Quijano-Evans of Gemcorp Capital, a longtime emerging markets specialist, says investors had been thrown off 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 emerging markets.
Investors in developed countries, Mr. Quijano-Evans says, 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 emerging markets stocks, he says, 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 says. “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.”
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