Emerging markets… it ain’t growth

The common mantra we hear quite frequently is that investors need to be invested in emerging markets because that’s where the growth is (“emerging middle class”, “growing population”, “emerging consumer”, “sclerotic hopeless developed countries”, “technology take-up” etc.). Sounds pretty reasonable on the surface, so let’s take a look at the responsiveness of absolute and relative emerging market equity returns to absolute and relative GDP growth. If growth matters it should be pretty self-evident in the data.

The first chart shows emerging market local currency equity index returns plotted against nominal GDP growth.

There appears to be no relationship here at all – the R-squared coefficient is zero (for the statistically-minded that means that none of the variance in EME (emerging market equity) returns is explained by emerging market GDP growth. And, yes, there can be alpha with no correlation).


Ah, but perhaps there is a lag, so let’s look at EME returns with a one-year lag to GDP growth.


Again, nothing.

Thomas Huxley’s wonderful quote comes to mind “The great tragedy of Science – the slaying of a beautiful hypothesis by an ugly fact”.

Looks like the variability of EME returns are not well explained by GDP growth at all.

What if we look at the relative performance of EME vs world equities against the relative GDP growth of developing and advanced countries?

Nothing changes. We can say pretty confidently that faster growth in the developing world versus the developed world are of no consequence for relative equity returns.


What if we get more granular and look at individual markets? The following chart looks at the growth versus returns relationship for Brazil over the last fifteen years (constrained by data limitations).

Once again, the story is familiar, it ain’t growth variability driving the Brazilian equity market.


Mix real and nominal variables (not for the purist, admittedly, but let’s do it) or impose lags and the picture doesn’t change at all.

So, the next time “emerging market equity” and “growth” appear together think hard about that relationship (or lack of, in reality).

The case for EME is far more subtle than superior growth = superior returns.

  • The dilution from equity issuance to finance the growth must be considered.
  • The source, scale and cost of capital to and from developing countries must be considered.
  • Valuation and risk premia must be considered.
  • The distribution of the returns to growth between owners of capital and agents for capital (wages, empire building, dividends) must be considered – shareholders are not the only potential beneficiaries from aggregate earnings growth.

Today, the structural unwinding of $6 trillion or more of net capital inflow into the emerging markets in the last cycles is the dominant theme, in our view, and only when that has played out fully would we be confident in investing in emerging markets (by which time valuation and momentum will, hopefully, both be enticing).