The brief market correction earlier this spring highlights the current bullish sentiment driving stock prices upwards. Despite a 5.4% dip in the S&P 500 between late March and mid-April, the market quickly recovered within a month, surpassing its previous losses. This rapid rebound signals a positive outlook, with investors focusing more on opportunities to buy rather than sell.
The broad recovery across the market also reflects this optimism. Lower interest rates are anticipated, prompting investors to look beyond market leaders and consider a wider range of stocks. For instance, the equal-weighted S&P 500 has reached its highest level since 2021, and 80% of companies now trade above their 200-day moving average. Similarly, smaller companies have experienced a breakout from their stagnant three-year performance.
A key factor in this recovery is the weakening of the US dollar, as the Federal Reserve is expected to align with other central banks in easing monetary policy. The dollar had gained strength earlier in the year, but is now headed for its first monthly decline in 2024. This shift has benefited risk assets such as commodities and emerging market equities, which have suffered under the Fed’s previously restrictive policies. Commodities priced in dollars, like copper, have surged in value, with the price of copper rising from $8,000 to nearly $11,000 per tonne since February. Gold and silver have also seen significant increases during this period.
Emerging markets have also benefited from the weaker dollar, which has reduced the burden of dollar-denominated debt. Shares in these markets have risen over 20% in the last six months, though China, the largest contributor, has only seen a modest 5% increase since October. Excluding China from the MSCI Emerging Market Index offers a more encouraging picture, with the rest of the developing world recovering all losses from the 2021 post-pandemic peak. However, emerging markets have largely remained stagnant over the past decade, while the US stock market has nearly tripled, raising questions about whether this trend may reverse in the coming years.
Emerging markets present a compelling investment case, both in the short term and for the long haul. In the near term, signs of a soft landing for the global economy, along with falling inflation, make current interest rates seem overly restrictive. This should lead to lower borrowing costs, while economic growth and corporate earnings remain robust, especially in emerging markets, where GDP growth is nearly 5%, more than triple that of developed economies.
Additionally, the economic fundamentals of emerging markets have significantly improved over the past decade. These nations are better positioned to handle shocks, with improved current account balances, less reliance on dollar-denominated debt, and higher foreign exchange reserves. Many emerging markets addressed inflation earlier than their developed counterparts, and some have already begun cutting interest rates.
Emerging markets are also poised to benefit from the growing commodities boom, particularly due to the global shift towards a net-zero economy. The increasing demand for key natural resources like copper and nickel, vital for clean energy infrastructure and electric vehicles, will provide further support. Furthermore, the emerging world’s dominance in semiconductor production offers exposure to the artificial intelligence revolution.
The long-term structural advantages of emerging markets include their demographic strength. In the near future, 90% of the world’s working-age population and two-thirds of its middle class will reside in emerging markets, driving economic growth. Despite accounting for 80% of global growth and nearly 60% of GDP, emerging markets represent just 11% of global stock market value. Their shares are priced more cheaply than those in developed markets, despite higher expected profit growth.
Investors can approach emerging markets through a variety of strategies, as these markets are highly diverse. India, with its booming service exports and growing manufacturing sector, is currently thriving, but its high valuations, especially in consumer sectors, make it expensive. China, on the other hand, faces significant challenges, including political risks and a fragile property market, but offers very low valuations for investors willing to take the risk.
There is a strong case for maintaining exposure to emerging markets for long-term growth. At present, the stars seem aligned for both short-term gains and long-term potential in these regions.
While emerging markets have their risks, the combination of structural and tactical advantages makes them a promising investment opportunity for the near and distant future.
Fidelity Emerging Markets Limited (LON:FEML) is an investment trust that aims to achieve long-term capital growth from an actively managed portfolio made up primarily of securities and financial instruments providing exposure to emerging markets companies, both listed and unlisted.
