Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, March 12th, at 2:00 p.m. in London.
At Morgan Stanley, we think global growth will exceed expectations in 2021. But we also think that emerging market assets, both stocks and bonds, will generally underperform. On the surface, that seems inconsistent.
After all, emerging market economies tend to be more volatile and more cyclical. Many also produce commodities that are quite sensitive to economic demand. If global growth is going to recover more than expected, such countries would seem quite well-placed to benefit from that upswing.
Yet there's some nuance here that's important. The first is what's driving that upswing. And the second is the nature of emerging market assets that most investors buy.
Let's start with that upswing. With the recent passage of the $1.9T American Rescue Plan, it appears increasingly clear that the U.S. economy will be at the leading edge of a global recovery. But that creates some complications for emerging markets.
Better U.S. growth should mean higher U.S. interest rates, something that EM economies can be quite sensitive to. Those higher interest rates also make the U.S. dollar more attractive to hold, putting downward pressure on the value of many EM currencies.
Many EM economies, meanwhile, don't have the same ability as the U.S. or Europe to borrow to support their economic recoveries. So while the usual pattern is for these more volatile EM economies to rebound more than the U.S. as growth picks up; this year, we think they'll rebound less.
There's also the question of what one means by emerging market assets. If you go back 10 or especially 15 years, the MSCI Emerging Market Stock Index—a pretty popular benchmark—was dominated by banks and commodity producers. Both sectors tend to trade at low valuations and be highly sensitive to economic conditions.
But that's not the index today. At present, the five largest stocks in that same emerging market index are all in the technology sector and make up almost a quarter of the entire market. Four out of five of these stocks traded over 20x next year's earnings, a pretty hefty valuation multiple.
In short, a large part of the EM equity story is now caught up in the debate over just how much of a valuation premium do high quality technology companies deserve, rather than the debate over how strong is the global recovery going to be.
Stronger global growth should eventually improve the EM asset outlook. But for the time being, we see better opportunity in cheaper, more cyclical developed markets. Between now and year-end, we think stocks in Europe and Japan will be more attractive to own.
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