Coming out of the Global Financial Crisis, Emerging Market (EM) equities were the best performing regional equity market, returning 79% in 2009 versus the S&P 500’s 27% and developed markets (DM) ex-U.S.’s 33%. This year, EM is lagging behind with a 7% return versus the S&P 500’s 13% and DM ex-U.S.’s 10%. Why is EM underperforming DM during this year of the recovery? Part of the answer lies in the slower recovery happening in certain EM regions, like Southeast Asia and Latin America. More importantly, the EM equity universe has dramatically changed in the decade in between both recoveries, becoming much less cyclical and much more growth-oriented. It is no longer unexpected for EM to underperform during cyclical rallies when growth is out of favor. Instead, EM equities offer investors exposure to themes of the expansion ahead, such as the rise of the EM Asia middle class and technological innovation.

The global economy continues to make progress in moving on from the pandemic, but with still uneven regional trends. In EM regions outside of North Asia, such as Southeast Asia and Latin America, powerful second waves are causing a likely activity contraction in the second quarter. In addition, the pace of vaccinations remains slow. These EM regions have very cyclical equity markets, with over 60% of their markets made up of cyclical sectors. As a result, it is not surprising for these markets to be underperforming other cyclical markets, like Europe, where the recovery is gaining momentum.

While regional pandemic trends explain part of EM’s underperformance, a more important explanation is the EM market’s dramatic regional and sectoral change over the past decade. EM equities are now a growth market, not a cyclical one. The more cyclical EM regions have shrunk in size, while North Asia (China, Korea, and Taiwan) have moved up from 43% of the index in 2009 to 65% today. These are regions where “growth-y” sectors, like technology, dominate the market. As a result, the sectoral representation of the overall EM index has changed. Cyclical sectors have moved down from 63% of the index in 2009 to only 44% today, while technology has doubled in size from 11% to 20%. In a year when growth is out of favor and cyclicality is in favor, EM should now be expected to underperform.

For EM, this is a different beginning to a new cycle. For investors looking to add cyclicality in the year of the global recovery, Europe now offers one of the best cyclical bangs for the buck. Meanwhile, EM offers investors access to powerful structural growth stories of the expansion: technological innovation and the rise of the EM Asia middle class, themes that will come back into favor once investors look past the early cycle economic growth surge.

Very different beginning to a new cycle for EM equities

Percentage of MSCI Emerging Markets Index

Source: MSCI, J.P. Morgan Asset Management. Cyclical sectors include Consumer Discretionary, Financials, Industrials, Energy and Materials. The Internet and direct marketing subsector has been removed from the cyclicals calculation. In our judgement, companies in this space do not yet fit into the cyclical category, as they are still in a transitional growth phase and are not being directly impacted by the business cycle. EM North Asia includes China, Taiwan and South Korea. Data are as of June 2, 2021.

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