The Beauty Of A Rules-Based Approach In Emerging Markets

Over the past few years, it’s been difficult to make a reliable case for emerging market equities. Every time we take a closer look into this market, its low valuations tend to pique our interest, but it ends up underperforming U.S. equities nonetheless.

Let’s face it—this isn’t the easiest topic in today’s world.

And that’s exactly why this could be a great time to consider emerging market equities.

2018 Exhibited Some Mysterious Performance Characteristics

A few factors that tend to influence emerging market equity performance leap to the forefront of our considerations.

Factor 1: The U.S. dollar

The dollar appreciated in 2018, and the U.S. Federal Reserve raised the Federal Funds Rate as many times as had been expected—four. Historically speaking, this hasn’t been the best tailwind to emerging market equities.

Factor 2: Oil prices 

This matters a lot to major oil-exporting countries (like Russia), and not nearly as much to others that are more import-focused (like India). For the full year, Brent Crude oil fell from about $67 per barrel to about $54—a 20% drop. During the year, the price rose all the way to levels above $85, and then proceeded to drop to almost $50. To say the least, oil’s volatility was a major factor affecting global markets beyond just those in emerging markets.

So now, for the mystery:

During U.S. dollar appreciation, the currencies of more commodity-focused emerging markets tend to be more volatile and depreciate more. If we also know the price of oil has dropped significantly—and many commodity exporters in emerging markets are oil-focused—we’d also predict that these countries would have struggled during the year.

  • In figure 1, however, Qatar, Peru, Brazil, and Russia were the top four country performers for 2018. Each outperformed the broader MSCI Emerging Markets Index benchmark by more than 10%. Each country is heavily involved in the petroleum industry. Figure 1’s returns are also in U.S. dollars, thereby showing both the impact of the equity returns as well as the currency returns against the U.S. dollar. Despite a tough environment for oil, these countries delivered.
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