London - Emerging-market stocks generated their strongest quarterly gain in over a decade, with the MSCI Emerging Markets Index rising 19.70% in Q4 2020, supported by U.S. dollar weakness. Looking ahead, emerging markets may continue to benefit from strength in North Asia and ongoing global economic recovery.
U.S. election results and positive coronavirus vaccine news boosted risk assets at year-end, eclipsing worries about a third wave of the pandemic which took hold in Europe and the U.S. The rally in commodity prices was supportive of emerging-market exporters and USD weakness amplified returns.
Rotation of country leaders
Emerging equity markets cheered the perceived light at the end of the tunnel, with the year's biggest losers gaining the most in the final quarter of 2020: Columbia, Brazil, Mexico, Peru, Czech Republic, Hungary, Turkey and Thailand all returned more than 20%. South Korea also performed well, aided by strong gains from the technology sector, and India outperformed, as the number of reported new COVID-19 cases declined.
Conversely, Egypt was the worst-performing market, where the number of new daily cases accelerated. China, which led markets for most of the year, delivered positive returns but lagged as rising tensions with the U.S. and anti-trust moves weighed on sentiment.
Areas of opportunity and risk
At a country level, we have ongoing concerns around China, given escalating geopolitical tensions and domestic risks. Conversely, Korea and Taiwan appear attractive, given their strong capabilities in semiconductors, memory, 5G, automation, artificial intelligence and electric vehicles. Mexico shows no major vulnerability and may be positioned to benefit from a strong earnings rebound in 2021.
In our view, the most vulnerable markets include South Africa, Saudi Arabia, Malaysia, the Philippines, Argentina and Columbia, and they are not currently attractive for investment. Brazil appears weak, given its fragile fiscal situation, weak domestic sector and elevated valuations.
Positive outlook for 2021
After their surprisingly robust recovery in 2020, emerging-market equities look on track for a positive year in 2021. North Asia, which constitutes most of the MSCI Emerging Markets Index, exhibited notable competence in dealing with the virus and, thus, looks set to build on last year's good numbers.
North Asia, however, doesn't appear to be the only region with attractive prospects. As vaccines are distributed and investor and consumer confidence return, the global economy should likely see a recovery in the second half of the year, helping commodity producers like Indonesia, Peru, Russia and Mexico. Emerging-market valuations also appear supportive, as they are at the low end of their long-term range relative to developed markets.
In Latin America, although local politics may remain volatile, economic growth may be positive, even if not all countries in the region have secured vaccines. The region of Europe, the Middle East and Africa (EMEA) may see a more difficult U.S./Russia relationship, but higher demand for energy, base metals and platinum/palladium should aid Russia and South Africa. However, politics will remain challenging in the latter, and prospects are dim for the current rally to last through 2021.
On a sector basis, overall, we believe 2021 is likely to be a good year for financials and materials. Longer term, however, we do not see high economic growth rates continuing, so cyclicals remain more of a trade for 2021 than a secular investment. Secular trends like digitalization and increased spending on health care, logistics and premium products should continue, with growing demand from the emergent middle class.
Bottom line: We believe emerging markets offer attractive growth opportunities, both now and over the long term. We are carefully monitoring the path of COVID-19 and the global economic recovery to position our strategies strategically for either opportunities or challenges that may arise.
Index definition: MSCI Emerging Markets Index is an unmanaged index of emerging-market common stocks. MSCI indexes are net of foreign withholding taxes. Source: MSCI. MSCI data may not be reproduced or used for any other purpose. MSCI provides no warranties, has not prepared or approved this report, and has no liability hereunder.
