Examining the 2017 Surge in EM Equities

2017 has started off as a good year for equities around the world, with all major regions of the world rallying.  As measured by MSCI, the U.S. equity market has returned about 9.5% through June, while the non-U.S. developed market index, the “EAFE,” has returned more than 14%.  However, emerging markets have been 2017’s clear winner so far, with the MSCI EM index delivering returns approaching 19%.

Emerging markets have long been the laggards of the global equity markets, with five-year returns less than half those of the EAFE, and less than one quarter of those of the U.S.  Whether or not the market action so far in 2017 is a change in the long-term trend remains to be seen, but the stellar performance thus far warrants further examination.

As long-time readers of mine are aware, currency movements play a larger role in relative (to U.S., that is) equity returns for emerging markets than in many developed nation markets, so 2017’s good start for EM stocks begins with the weakening of the dollar against competing currencies.  Per the Federal Reserve’s most recent currency data (updated through about mid-July), the broad dollar index has dropped a little more than 5% so far this year, but against a few major emerging market currencies such as the South Korean won and the Mexican peso, the dollar has declined considerably more, thereby boosting equities from those countries in dollar terms: [Note: excess performance refers to country returns less U.S. returns.]

The second key contributor to EM’s big year is that the index has changed dramatically in terms of composition.  In 2008, MSCI’s EM index was heavily tilted toward energy and materials.  In 2017, the same index is now similar to the U.S. market in that it has a heavy technology concentration, and also a heavy consumer concentration: [Note:  I followed Legg Mason’s example and combined consumer staples and consumer discretionary into one “consumer” sector.  I extrapolated the returns for this combined sector using the most recent weightings.  I also excluded real estate from 2017’s allocation and re-weighted the index.]

[right click on graphic, “open image in new tab” to enlarge]

To show how important this change in composition has been, it is instructive to play a “what if,” and see how 2017’s performance would shape up were the 2008 composition still in place today:

Essentially, the change in composition is responsible for what amounts to an additional 486 basis points of performance so far in 2017 (through June), which is no negligible amount.

It should be mentioned, too, however, that there is nothing unique about EM’s performance thus far in 2017.  For example, the MSCI USA technology index is also up handsomely at about 17%, while the comparable ex-USA developed market technology index is up almost 30% so far this year.  EM are too often pitched as asset classes unto themselves.  They, of course, are not.  Returns in EM are basically from currency movements and the broader cycles playing out across the globe.  For EM, 2017 is a classic example of how a weaker dollar and huge exposure to winning sectors has equaled EM outperformance.  Astute investors should not be all that surprised.

Sources and additional reading:

Legg Mason report on EM


Cycles, Sectors, and the Perils of Aggregated Data


Disclosure:  The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Fortune Financial Advisors, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Fortune Financial Advisors, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.