Everything you thought you knew about emerging markets is wrong
Say the words 'emerging markets' to an investor and two phrases usually trip off their lips: high growth, high risk.
It is the accepted wisdom that emerging markets adds a little fizz to an investment portfolio. They give you higher returns but there’s more chance you lose your money.
New research presented this morning at the palatial Credit Suisse offices on Pall Mall casts doubt on the received wisdom – or at the very least, shows the phenomenon to be more nuanced.
This chart shows it best.
Emerging markets have underperformed developed markets (let’s call it DM) over the long run of 113 years. Since 1950 they’ve grown faster than DM – at 12.5 per cent versus 10.8 per cent – but this has not been enough to catch up.
“This happened because of Japan and China in the 1940’s,” London Business School’s Paul Marsh, who co-authored the research, said today. “That’s when the damage was done.”
Between 1945 and 1949 emerging market stocks collapsed. After the World War II, Japanese equities lost 98 per cent of their value. In 1949, another major emerging market powerhouse, China, closed equity markets completely after communists took power. Emerging markets have never recovered.
So where did the received wisdom of emerging market’s powerhouse growth potential come from? It seems to have taken root in the first decade of this century, as this graph demonstrates.
As you can see, emerging markets stormed through the noughties while developed markets faltered (note the collapse in the 1940’s).
The first three years of this decade have seen a reversal, showing something more akin to relationship between emerging markets and developed markets the 1980’s and 1990’s – a trend likely to concern emerging market investors.
On the risk side, the accepted wisdom of emerging markets has also been misjudged. As the report’s authors – Marsh, Elroy Dimson and Mike Staunton – make clear, the terms “emerging market” and “crisis” seem a natural pair. But look at this chart.
It shows that emerging markets crisis contagion is not the norm; DM crises are more contagious, undermining the notion that problems in emerging market currency and macroeconomic are the nasty problems that infect developed markets.
The truth is, developed markets infect emerging markets.
Emerging markets are going through something of a mini-crisis recently. As today's findings show, the situation is a lot more complex than a recent memory suggests.