EM Stocks Doing Better, Except for Drag From China, Ned Davis Says

China used to dominate the MSCI Emerging Market Index, with a 40% weight as of 2020. Today? Its share has shrunk to 25%, still the leader, but nearer to the levels captured by other EM powerhouses, such as Taiwan (19.4%) and India (19.2%).

It turns out that those other EM nations have enjoyed big economic and market increases that have compensated for the woes in China. The Shanghai Composite is up a mere 0.25% this year, while Turkey’s exchange has risen 49%, Taiwan’s 27.5%, India’s 11.6% and South Korea’s 5.3%. The overall MSCI EM index is up 7.5% this year through Thursday.

For 2024 through June 30, emerging markets climbed 20% without counting Chinese stocks, but 9.8% with China included, MSCI found. Over the past five years, the China-excluded index beat the full roster by almost two percentage points yearly. Five countries constitute 80% of the EM index’s weight: China, India, Taiwan, South Korea and Brazil.

“China has not participated” in the EM surge, said Tim Hayes, chief global economist at Ned David Research, in an interview about his report on the subject. To be sure, the EM index’s 2024 performance lags behind that of the S&P 500, which is up 16.2% as of Thursday’s close.

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The problem with China is its continuing post-pandemic economic funk, reflected in its equity market. Troubles in its overbuilt property sector, which triggered a debt crisis, and low domestic confidence dog its equities’ returns. Chinese stocks have lost more than $4 billion in value since 2021. So, more broadly, as of the 15 years ending June 30, the EM index rose 9.8% annually, but excluding China, it was ahead 20%, MSCI noted.

How times have changed. In the previous decade, China’s high growth juiced its stocks and was the propellant for the EM index. In 2019, for instance, the index rose 18.4%, but if China were excluded, results were two percentage points lower.

U.S. pension funds and endowments have energetically invested in China for years, a study by the Future Union, an advocacy organization, pointed out. It found that public pension funds in 43 U.S. states held investments in China and Hong Kong, as of mid-2023. Over the previous 36 months from summer 2023, for instance, the California Public Employees’ Retirement System made 80 EM investments, worth an total of $7.86 billion.

Things may be changing, though. The Teacher Retirement System of Texas recently decided to reduce its EM allocation to 1% of its assets from 9% and to remove China from its benchmark. The fund indicated it feels developed markets will do better than emerging ones in the future.

Nonetheless, in mid-July, the NDR report stated, MSCI emerging market indexes “have accounted for eight of the top nine performers over the past 21 days, all outperforming the U.S.” and the MSCI All Country World Index. Chinese stocks were down 4% over the same period, the report noted.

Thus, the emerging markets have shown greater breadth, with the exception of laggard China, the report observed. The 24 EM components of the ACWI, it said, are “above its 50-day moving average and ha[ve] been reaching record highs, with 8% of the markets at one-year highs and none reaching new lows.”

According to the Ned Davis report, declining interest rates globally should fuel EMs, which need to borrow a lot. The bellwether 10-year Treasury’s yield is down half a percentage point since its yearly high in April, when inflation fears still prevailed. The outlook on inflation now is for a continued cooling.

Meanwhile, several EM central banks have cut interest rates over the past year, with more expected soon, per S&P Global. Eight of them have cut over the past year, Ned Davis wrote. China, though, has not reduced its rate (3.5%) since 2015. Many other EMs are below China’s level. Taiwan, for example, is at 3.1% and is anticipated to reduce that further soon.

Ned Davis’ model, its report indicated, “currently calls for maintaining the overweight exposure” to the MSCI EM index, with a caveat: “It’s advisable to exclude China from that exposure.”