MSCI Emerging Market index: An overview, recent trends and the future performance forecast

An overview of the index

The MSCI Emerging Markets Index consists of mainly large and mid-cap shares from 26 emerging countries. With nearly 1400 constituent stocks, the index covers over 80% market capitalization in major emerging markets including Greater China, South Korean, India, Brazil, most ASEAN countries, East Europe, Russia and some middle east countries.

The sector analysis of the emerging market index

The global economic growth is still dominated by the technology and the consumer discretionary sectors, so is the prospect of emerging markets.

Based on the data by MSCI and as of 30 Oct 2020, the MSCI emerging market index has a large proportion in the consumer discretionary and information technology industries in the likes of big e-commerce/tech magnate like Alibaba.

Following the influx of growth in more Chinese tech companies, we believe the weigh and influence of these listed enterprises will increase in the index. Conversely, this high growth and market dominance of big tech names will be the driver for prices of emerging market index in the long run, coupled with the resurrection of constituents within the cyclical sector especially the high-weigh banking sector after the pandemic.

The main drivers and the historical performance of the MSCI Emerging Market index

The Emerging Market index showed some distinctive characteristics when compared to similar indexes in the likes of MSCI ACWI (consisting both developed and emerging market) and the developed markets index (MSCI World).

However, during the non-Crisis period, the developed markets index and the MSCI ACWI index had reflected a more stable performance, as seen in the 3YR, 5YR and 10 YR annualized return (it should be a geometric mean return instead of an arithmetic mean) of the developed markets index displayed an increasing trend 5.96%, 8.13% and 8.64% respectively. In contrary, the emerging market index exhibited uncertain trends with its return; their 5 YR return was at its highest of 7.92%, while the 3YR and the 10 YR return were both under 3%. This was at the back of unexpected policy changes in the Chinese financial sector, decelerating growth in the Greater China economy and stock market fluctuation in major emerging countries including South Korea, India and Brazil, resulting in the volatility of the emerging market index in the past 10 years. The volatility and riskier nature of the emerging market index is also reflected in the higher standard deviations and small Sharpe ratios as we see in the lower part of the below chart.

With the characteristics of the index in mind, such fluctuation of the emerging market index can provide traders an opportunistic avenue to take a short/long position in the shorter time frame. On top of that, the Emerging Market index has also shown better performance during the 2020 Covid-19 crisis with an annualized return of 8.79% (since 2000), beating the other two indexes. Having the highest 20-years Sharpe ratio (0.42) amongst all three indexes under the most unfavourable standard deviation data does indicate that the emerging market has the highest return in the longer horizon (2000-2020). Despite unprecedented times due to Covid-19, the emerging market index has shown strong recovery with its constituents in the likes of mainland China and ASEAN countries executing better virus management, which perhaps may lead to more potential growths from here.

Present performance and the future outlook

What drove the performance for the index?

The biggest four components take up more than 20% of the index and are namely Alibaba, Tencent, TSMC and Samsung Electronics which have all posted strong price rallies after March 2020 supporting the index to jump higher post the initial pandemic level. With the exception of Samsung Electronics, the other three shares’ reported a peak in their prices after March which are nearly a double of their share prices’ low in March 2020. Tencent’s online games development capability, Alibaba’s e-commerce platform and TSMC’s nanometre chip design and manufacturing ability are core competence that make these companies thrive in the pandemic. Whereas Samsung electronics fall behind as they are directly impacted by the global smartphone trade and supply chain disruption which has slowed down during this period.

Ever since March 2020, the emerging market index has rallied following the rise of these three major components. On the flip side, constituents that belong to the cyclical sectors may have seen a fall in prices showing a weaker rebound compared to big tech components.

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What’s the outlook in the short run?

The cyclical sectors and the Asian emerging market will be crucial and one to watch for any index’s development in the near future.

Under the Biden’s new presidency, a higher tax and current valuation of the big techs may also hinder big blue chip companies’ (especially tech magnates)share prices to climb higher, as we see the Nasdaq and S&P 500 meet resistance at the current historical high level. The emerging market tech constituents including Alibaba, TSMC and Tencent may also retrace or fluctuate at the current highs similar to companies listed on the Nasdaq.

Hence, under the current environment where the tech sector may be overvalued, the recovery in the cyclical sectors will be one to watch for any turnround to drive the emerging market index.

The northern hemisphere second wave and the uncertainty of Indian and Brazilian economy will also have negative implications on the index’s future development. The Indian, Brazilian and other ex-Asia emerging markets components account for more than 20% in the index which may implicate the performance of the index due to their country’s slowdown in economy. Though the Chinese market still can drive up the index under the fact that China may be the only major economy to record a positive YoY GDP growth in 2020. We believe if Greater China and the Asian emerging market keep growing at its current pace, the emerging market index will potentially climb further in the short run in hope of a better Asian recovery from the pandemic

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