Year of the Dog reflections: how did emerging markets do?

At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about economic, political and financial developments that are likely to have an impact on the way in which institutional investors assign their money. And then, one year later, we revisit these forecasts to see how well we did.

We begin revisiting our Year of the Dog predictions by considering our prediction of the performance of emerging market stocks.

What will be the best performing mainstream asset class, on a risk-adjusted basis?

Answer: Emerging market stocks - incorrect 

This was not the best start to revisit our predictions of 2018.

Emerging market stocks had a dreadful year, serving as a reminder that they are often the tail wagged by the dog of the US. After a decent start to the year, stocks began to struggle as geopolitical noise swiftly grew between the US and China, instigated by US president Donald Trump's desire for trade confrontation. 

This mounting tension exacerbated existing fears over signs that China's economy was experiencing relative weakness. Meanwhile other signs of economic or political difficulties emerged in emerging markets such as Venezuela, Argentina, South Africa and others. A strengthening dollar for much of the year only served to add pressure onto many emerging countries. 

Then, late in the year, a win by the Democratic party of the US House of Representatives promised political brinkmanship with Trump. Elsewhere the UK appeared to collapse into a political malaise over how best to sever its ties with the European Union ahead of a March 2019 deadline, while concerns lingered over Italy's populist government and mounting dissatisfaction with the government of French president Emmanuel Macron. Investor confidence further dissipated. 

It's a long-held truism that when investor sentiment ebbs, emerging markets are typically one of the first asset classes to suffer. The MSCI Emerging Markets Index offers a concise example: it fell 14.57% during the whole of 2018, versus a smaller (but still sizeable) 8.71% fall for the MSCI World index.  

Back in early 2018, this was harder to foretell. True, US stocks looked overvalued; price to earnings valuations had ballooned to reach 34.52 for the S&P 500 index on January 29, 2018. But the fundamentals of the global economy were sound, with the World Bank predicting global GDP growth of 3.1% for the year. That combination made it look more likely that emerging market stocks could continue benefiting, despite a strong run in 2017.

We believed many investors still held slight underweight positions for emerging market positions, and they would balance these to at least neutral weightings. Sadly, it was not to be. Instead, rapidly scaling market uncertainties and emerging worries about a US recession led investors to pull back from equities in general, and emerging market stocks in particular.

And as 2019 begins, these fears have yet to abate. Emerging market stocks could be in for another volatile year.