Emerging Markets Look Poised for a Good 2021, Says Lazard

Things are looking up for emerging markets (EM) and their stocks, after a brief spate of pessimism due to rising Treasury yields this winter. Lazard Asset Management thinks that faster overall global growth, modestly rising interest rates, and a rebound in commodities prices will keep their recovery on track.

“Our outlook for emerging markets equities overall remains positive in anticipation of a stronger rebound in global growth over 2021,” the firm’s analysts wrote in a research report.

But there are headwinds to overcome. Optimism about heady US economic growth this year has drawn capital out of emerging markets, forcing some developing countries like Brazil to raise interest rates despite lingering economic weakness.

Plus, a somewhat stronger dollar adds to EM nations’ cost of paying their foreign-currency debt. The buck slid against a basket of other currencies last year, but in 2021 is up 1.26%.

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Thus far this year, the MSCI EM index is up just 4.4%, while the MSCI World Index is up 9.4% and the S&P 500 has climbed 10.8%. In February, the EM index tumbled by one-tenth and only now is nudging back. That benchmark had a pretty good 2020, as oil and other commodities recovered: It rose 18.31%, just about in line with the S&P.

Energy prices are a key factor. For emerging markets, higher oil prices have a lot of pluses and some minuses, according to Lazard. Exporters such as Russia and much of Latin America stand to do well, while importers like India will struggle to pay the higher petroleum prices. Crude, now at $63 per barrel, is up from $14 a year ago.

The Lazard report sketched EMs’ progress this year, starting out in January with economic optimism surrounding the vaccines. Fiscal stimulus in the US and other developed nations built expectations for stronger economies there, which would bolster demand for EM products.

But by mid-February, US Treasury bond yields pushed higher, amid talk of higher inflation. Central banks in Brazil, Russia, and Turkey also lifted their rates, which risked dampening EM growth. Emerging markets equities flagged.

Lazard’s outlook for emerging markets equities overall remains positive in anticipation of a stronger rebound in global growth during 2021. “Interest rates remain a factor to watch closely, however,” it warned. The yield on the 10-year US Treasury bond has risen steadily since last August, from 0.5% to 1.7% by the end of March. During this time, emerging markets equities continued to push higher.

Nevertheless, the rate rises seemingly have leveled off. The 10-year Treasury topped out at 1.75% at the end of March, and now has dipped to 1.6%. As Lazard put the matter: “When yields are gradually rising due to a strong recovery in economic growth, emerging markets can outperform, particularly the economically sensitive, traditional value securities, such as materials, energy, and financials.”

Net-net, the picture looks good. “We continue to see opportunities in emerging markets corporates and shorter-dated high yield sovereigns,” Lazard stated, “and we expect currencies to offer better beta opportunities in the second half of the year.”

Why a Standalone China Allocation Still Makes Sense

For many US investors, China comes with a grocery list of environmental and regulatory issues. It is still dependent on coal energy, after all.

By the measure of FTSE Russell, Chinese businesses scored lowest for corporate social responsibility among larger markets, the Willis report said. It received 1.5 out of 5, when the average emerging market nation scored 2.1 in the FTSE4Good rating.

Regardless, Willis’ consultants argued that the growing momentum in ESG investing in China suggests there will be greater sustainable returns over time, particularly as more foreign investors access its markets.

“They have built up strong positive momentum and we’re expecting that positive momentum to continue over the coming years and decades,” said Liang Yin, director of private equity research and project lead on China at Willis Towers Watson.

At the moment, investors in the US have a relatively miniscule allocation to Beijing. Despite holding the world’s second-largest equity and bond markets—with a $12 trillion market value—the country accounts for about 5% of the MSCI All Country World Index (ACWI). Experts say that is not an even distribution given China’s growing share of the world’s capital markets.

“That’s just not a very resilient portfolio going forward, in particular, into an emerging world order,” Yin said. “Of course, no one knows what the new world order will look like, but I think investors should prepare for all possibilities.”

Last year, Willis told global investors they should be making a standalone allocation to China, investing up to one-fifth, or 20%, of their return-seeking portfolios to the country by 2030.

The Chinese government is also working to bring sustainability mainstream. Last year, at the United Nations General Assembly, Chinese President Xi Jinping pledged that his country would reach carbon neutral by 2060.

With the backing of the Beijing government, ESG disclosure practice in China is already stronger than it is in the US, according to ESG data from Bloomberg. More than one-quarter of A-share companies issued ESG information in 2019.

Willis also reported that local asset managers are under pressure to develop ESG disclosures to attract international investors.