Emerging and developed equity markets this year are tracking each other rather closely. As we show in the chart below, this has not always been the case.
Between 1990 and 1995, emerging market (EM) equities made their first significant bow on the global capital market stage and outperformed the US S&P 500, the leading developed market benchmark, by some 80%. After 1995 and until 2000, they lost all of this ground gained and much more in relative performance. EM was again the preferred flavour after 2000 until the Global Financial Crisis, an event that took even more out of EM valuations than the out of the S&P and other developed equity Indexes. EM, then in recovery from the global recession, outperformed the S&P 500 until 2010, but then became a decided outperformer until this year.
EM equities are more risky than developed markets and therefore, in order to attract investor interest, they should promise higher returns. Such higher returns are expected to come from the stronger growth in earnings expected from EM companies participating in faster growing economies. Such earnings expectations are not always satisfied. They were not well satisfied after 2010 when the average EM company delivered significant less extra earnings than did their competitors on the developed exchanges. It was this earnings disappointment that presumably held back EM valuations.
It may also be noticed that in 2014 EM earnings have outpaced S&P earnings. This surely has had something to do with the improved relative performance of EM equities in 2014.
The earnings indicated here are one year forward earnings expected by the analysts rather than reported or trailing earnings. We show below that forward S&P and EM earnings are now growing at about the same rate while, if recent trends are sustained, the time series forecast is for EM earnings growth to outpace still satisfactory S&P earnings growth.
Such trends, if confirmed, will add to the case for EMs given their somewhat less demanding earnings multiples, as show in the next chart. A combination of decent earnings growth and less risk priced into these earnings expectations could easily attract renewed enthusiasm for EM markets generally.
Any growing investor interest in EM equities would mean additional flows towards the EM companies listed on the JSE. This in turn would be helpful to the exchange value of the rand and so help restrain SA inflation and perhaps lead to lower interest rates in SA. Such inflation and interest rate trends would help revive the much subdued SA consumer, whose willingness to spend is an essential ingredient for faster SA economic growth. Much rides, as always, on the global appetite for EM equities and bonds.
It will have been noticed in the figure above, that the SA component of the EM bench mark Index, MSCI SA, is even more demandingly valued than the average EM equity market in which SA had an approximately 8% weight. The MSCI SA Index (one that excludes the dual listed companies) however has consistently behaved very much like the average EM market. It has done so because MSCI earnings have consistently matched those of the EM average.
The SA economy may have lower economic growth rates than the average EM economy. But the average JSE-listed company has consistently increased its earnings in US dollars at about the same rate as the EM average. The close relationship between the JSE in US dollars and the EM benchmark, is thus no coincidence. It is well explained by comparative earnings in US dollars.
How does the earnings contribution of companies get accounted for in the Research? In the 90’s companies listed on developed markets, would have had less earnings contribution from their global expansion into emerging markets. Now, they are still listed on the S&P but competing for profits locally with a JSE listed company.
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