Learn here about the four major factors that affect emerging market performance and what they mean for international investors.
Developed Market Demand
Many emerging market countries make products and/or sell services to developed market economies. For instance, China makes all kinds of goods for the United States and Europe, while India is a leading exporter of information technology services. A downturn in developed economies can, therefore, hurt emerging markets that rely on demand to bolster their economic growth. Many developed countries struggled to return to normal growth rates after the 2008 financial crisis. Yet, things have turned around globally since the pandemic. The Organisation for Economic Cooperation and Development (OECD) projects global nominal gross domestic product (GDP) will hover between 4% and 5% through 2023, up from a pre-pandemic 2.3% at the end of 2019.
Domestic Economy Performance
Many emerging market countries are driven by domestic demand rather than export demand. For example, exports (goods and services) to the United States accounted for just $87.4 billion of India’s $2.9 trillion (nominal) economy in 2019—or less than 1% of its total economic output. China’s $615.2 billion in exports (goods and services) to the U.S. accounted for less than 1% of its $14.1 trillion (nominal) economy in 2020. Domestic factors—such as consumption and politics—have big influences on these emerging markets. Often, emerging market economies evolve from an export-driven economy to a domestic-focused economy. China’s transition took growth rates from more than 10% in 2010 to less than 3% by 2020. The upshot is that domestically powered economic growth is widely viewed as more stable than export-driven growth, since it doesn’t depend on external factors.
Currency Market Dynamics
Many emerging market countries have unstable local currencies. They must issue debt in dollar-denominated bonds. When the U.S. dollar value rises, these debts may become more costly to service for emerging markets that earn revenue in local currency. A higher dollar valuation also implies higher interest rates. This tends to draw capital away from emerging markets, making it cost more to raise future capital. For example, the U.S. dollar has witnessed a long-term increase in purchasing power parity (PPP, measured in national currency per U.S. dollar ) in emerging markets (Brazil, Russia, India, and China). There has also been a decrease or flatline in developed markets (Germany, Canada, the UK, and Denmark) over the long run.
Commodity Performance
Many emerging market countries are net exporters of commodities. This makes them sensitive to changes in commodity prices. Russia, for instance, is a large exporter of natural gas to Europe. Brazil exports iron ore, soybeans, coffee, and crude oil to China and the United States. A downturn in these commodities could have a major impact on the revenue generated by state-owned and private enterprises in these countries. Commodity prices were falling throughout much of the 2010s due to slower end-market demand. But the global economic recovery following the pandemic (coupled with persistent supply chain issues) is boosting demand and commodity prices.
The Bottom Line
Emerging markets are a great way to diversify any portfolio. Know the underlying drivers to improve your chances of success. Strong (though volatile) performance in the decade between 2010-2020 suggest those without emerging market holdings may want to add the asset class as these trends play out.
