The unrelenting upward march of the US stock market, and its tech constituents in particular, has meant investors have not needed to seek out alternatives in the past decade. But, in today's global theme, we see a number of factors aligning in support of the relative case for the Frontier and small Emerging market asset class in the 2020s.
- Lower rates and quantitative easing resumes in developed markets (which drives higher risk appetite).
- The search for yield and the easier availability of capital for sovereigns in Frontier and Emerging markets. While they might be more indebted than a decade ago, they are at much lower levels than Developed peers.
- Slower growth in the US and the EU, which makes more glaring the gap between macroeconomic growth in Frontier and Emerging compared with Developed, and which likely caps strength in the US$.
- Questions are increasing over the very long-term stature of the US$ as the default reserve (safe-haven) currency. Overall debt levels in the US economy are high, there is less policy predictability in an era of populist politicians, the ramp-up of economic tools, such as sanctions, in the US foreign policy kit. And Frontier and Emerging markets are benefiting from increasing trade flows with China, which encourages international powers to establish contracts in alternative currencies to the US$.
- Political populism, propensity for protest, and vulnerability to terror and insecurity are no longer so clearly more common in Frontier and small Emerging compared with Developed and large Emerging.
- Growth in the two largest emerging markets, China and India, is decelerating (which means that these two markets alone and the EM index they dominate may no longer offer such a straightforward option for international diversification outside developed markets for US asset allocators).
- Mega-cap tech in both developed and emerging (which have handsomely outperformed all other equities globally) is slowing (the law of large numbers).
- Many of the most vulnerable currencies in Frontier and small Emerging have already collapsed or significantly weakened (eg Argentina, Egypt, Ghana, Kazakhstan, Mexico, Nigeria, Pakistan, Philippines, Turkey, Zimbabwe).
- Economic policies and political transitions in most Frontier and small Emerging are increasingly orthodox and orderly (economic policies of the type seen in eg Dragnea’s Romania, Erdogan’s Turkey, or Magafuli’s Tanzania are the exceptions, not the norm).
Good companies have rarely been valued so attractively and ignored so widely by international and local investors.
Chart: Valuation relative to history
Source: Bloomberg, *denotes local index (except for MSCI Bangladesh IMI), otherwise MSCI (1 November)
It is possible that developed market stocks could repeat this decade’s stellar performance in the 2020s. And it is also possible that small EM and Frontier could continue to underperform, or be forgotten entirely. But we prefer the alternative hypothesis. The darkest hour is just before the dawn.
Read our full 2020s Vision: 20 themes for the next decade report.