The Futures of Emerging Markets Decoupled
Investors in emerging markets (EM) begin 2023 with historically low valuations and softened U.S. dollar strength. And in some regional blocs, notably the one represented by the MSCI EM Asia Index, forecasted growth is higher than in developed markets.1 When we look back at 2022, while the MSCI Emerging Markets Index was down nearly 20%, there was significant dislocation in the underlying performance. The three-month implied volatility for EM options has remained elevated.2
Differentiating local and international revenue exposure
Emerging markets generally have high economic exposures to local companies as shown below. For example, Brazil contributed the most to the outperformance of the MSCI EM Latin America Index, benefitted mainly due to cheaper valuations, high commodity prices and currency appreciation. The outperformance of the MSCI India Index in 2022 coincided with a sharp rebound in economic activity and relatively higher GDP growth forecasts. Chinese equities declined due to a variety of factors, and the strong U.S. dollar weighed down Taiwanese equities, as more than a third of their revenues were linked to U.S. firms.
Listed futures linked to EM, blocs and single countries
The wide decoupling within EM may present opportunities for investors to consider multi-country, multi-currency EM or single-country futures, to express asset allocation decisions, make tactical adjustments or cash equitization. International investors may seek to replicate currency-unhedged or hedged single-country exposures using USD denominated futures contracts. Some investors that benchmark China separate from the rest of EM have found futures linked to the MSCI China A50 and MSCI EM ex China indexes effective tools in aligning exposures.
Active performance attribution and P/E ratios (current, 10-year average)
Emerging markets’ economic exposures
1 Source: OECD Economic Outlook. As of Nov. 2022.
2 Source: Option metrics. Three-month implied volatility for EM options was 22.8% as of Dec. 30, 2022, with levels briefly crossing the 95th percentile in March while topping 70th percentile for most of 2022. Based on the last five years of implied volatility on the 91-day ATM call and put options on the MSCI Emerging Markets Index.
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