As the world remains
in the grip of the coronavirus, we’ve received many questions about the outlook
for Chinese and emerging market (EM) stocks—as China was ground zero for the
pandemic. First and foremost, we’re asked what the challenges and opportunities
are for that country and region?
Meanwhile, US and
developed market (DM) stocks have delivered outperformance for the past decade
or more. Will they continue to do so?
In many ways, we’re
witnessing the environment change and evolve in real time. From a market
perspective, perhaps the twin external shocks from the coronavirus and
plummeting oil prices may prove to be the catalysts for shifting leadership among
regions and countries.
In our view, the
outlook for Chinese and EM stocks may be better than many investors believe
because of a combination of factors: 1) China’s ironclad response to the
coronavirus and a flat case count; 2) a re-opened economy and rebounding business
activity; 3) cheaper valuations; 4) unprecedented US Federal Reserve (Fed) support
and a bearish technical setup for the US dollar; and 5) the relative
outperformance of Chinese stocks year to date, which we expect may continue.
Each of these warrants closer examination.
1. Coronavirus cases.
China was the first to implement draconian social-distancing controls and mass shutdowns to contain the coronavirus. The result was a relatively symmetrical flattening of the case curve, whereas the US continues to witness growing infection rates.
Figures 1 & 2. China has seemingly “flattened the curve.” The same cannot be said of the US.
2. Business activity
Such extreme, yet
effective, measures in China came at a steep cost—Beijing sacrificed near-term economic
growth, which plummeted to its worst levels on record. Presently, however,
China’s economic activity is rebounding in a v-shaped fashion, as evidenced by
the sharp improvement in its Purchasing Managers Index.
growing infection rates in the US likely mean the worst of the economic damage
may be yet to come.
Figure 3: Chinese business activity is staging a v-shaped recovery—rebounding sharply from record lows—while US activity is falling off the “COVID cliff” to record lows.
3. Valuations + catalyst
As one would expect, structural US outperformance inflated developed market valuations relative to the global benchmark, to emerging markets and to history. The rule of thumb is that overpaying for an asset reduces its prospective return over the long haul.
On the flip side,
structural EM underperformance—including China—has compressed valuations to
deep discounts. We believe compelling opportunities exist for investors in EM
stocks at a time when many emerging economies—especially those in Asia outside
of Japan—are recovering from the virus-related “sudden stop” in activity.
Leading indicators of
business activity across the emerging world—China and South Korea, in
particular—have been proving more resilient than those of the developed world,
including the US, Europe and Japan.
Low valuations and
improving economic growth could be a powerful combination for unlocking the
potential reward embedded in EM stocks.
Figure 4: Not all regions and countries are made equal. For selectivity, consider targeting low valuations and faster growth over high valuations and slower growth both across and within regions.
4. US dollar
One major challenge for
EM is the US dollar (USD) liquidity shortage and associated upward pressure on
the currency. However, the Fed—together with a host of other major central
banks—is doing its part to boost US dollar-based liquidity and tamp down the
greenback. At present, it appears the currency has stopped going up at such a
Looking ahead, we
believe the USD is unlikely to remain an obstacle for investors, as the
currency faces challenges in the form of ballooning US fiscal and current
account deficits, overvaluation and overbought extremes that warn of a
structural bear market for the greenback.
In our view, much of
the bad news has already been priced in, so investors shouldn’t get too
pessimistic on EM shares. History shows that bull markets are born in despair
and die in euphoria; we seem to be closer to the former than the latter.
Similarly, oversold extremes in the late 1980s and early 2000s were followed by
multi-year periods of EM outperformance. If past is prologue, this may be
another one of those episodes.
Figures 5 & 6: A flat to weaker US currency could boost EM stocks relative to their US competitors. Also, EM stocks bottomed in the depths of the last 3 US economic recessions—important chapters of the “recovery playbook.”
How is the thesis
playing out? We believe Chinese stocks have outperformed their US counterparts
because of cheaper valuations, an ironclad response to the coronavirus,
rebounding fundamentals and unprecedented Fed support.
In our opinion, the
key for sustained long-term outperformance remains the USD. While the Fed’s
doing its part to slow the currency’s ascent, investors’ appetite for risk may
have to firm for the USD to calm down. Perhaps Chinese stocks are already anticipating
Figure 7: Chinese stocks are leading the charge, a trend we expect may continue.
A Composite Purchasing
Managers Index captures the prevailing direction of economic trends in the
manufacturing and service sectors. It consists of a diffusion index that
summarizes whether market conditions, as viewed by purchasing managers, are
expanding, staying the same or contracting.
Institute for Supply
Management (ISM) is the first and largest not-for-profit professional supply
management organization worldwide.
The MSCI USA Index is
designed to measure large and mid market capitalization stocks in the United
The MSCI World Index
is designed to measure large and mid market capitalization stocks in the
The MSCI China Index
is designed to measure large and mid market capitalization stocks in China.
The MSCI Emerging
Markets Index is designed to measure large and mid market capitalization stocks
in the emerging markets.
Header Image: d3sign/ Getty
performance is no guarantee of future results.
investing involves risk, including risk of loss.
risks of investing in securities of foreign issuers, including emerging market
issuers, can include fluctuations in foreign currencies, political and economic
instability, and foreign taxation issues. Diversification
does not guarantee a profit or eliminate the risk of loss.
opinions referenced above are those of the authors as of May 14, 2020.
These comments should not be construed as recommendations, but as an
illustration of broader themes. Forward-looking statements are not guarantees
of future results. They involve risks, uncertainties and assumptions; there can
be no assurance that actual results will not differ materially from
expectations. This does not constitute a recommendation of any investment
strategy or product for a particular investor. The opinions expressed are those
of the authors, are based on current market conditions and are subject to
change without notice. These opinions may differ from those of other Invesco