Bring back the Dramamine. After a summer of light chop in the markets, the heavier seas have rolled back in so far this month. Volatility has returned, and its main drivers are familiar.
Early in the year, weakness in China’s economic data and falling oil prices drew concern about a global slowdown in overall demand. Meanwhile, the Federal Reserve was considering interest rate hikes, in addition to the one they pushed through back in December, which would have potentially weakened global economies further.
Markets declined sharply during the first six weeks of the year before bottoming in mid-February, as the data ultimately showed that the sell-off in oil was more supply-related than demand-related.
Markets recovered, absorbed the Brexit vote and just floated in a very tight range in July and August. Over the past two weeks, familiar fears over oil volatility and potential interest rate hikes have re-emerged, and equity markets are back to daily swings of 1-2%.
2016’s Big Surprise: Emerging Markets Take Off
After years of underperformance, culminating in a drop of almost 15% in the emerging-markets equity index last year, emerging-markets stocks have earned back the loss, with a gain of 14.8% through September 16. Emerging-markets debt has also tracked the rise in equities with a similar gain of 14%.
The recovery in commodity prices has helped quite a bit, with commodity-dependent economies like Brazil, Peru and Russia rising 62%, 52% and 26%, respectively, through August 31. As net exporters of things like oil, steel, precious metals, coffee and soybeans, these countries quickly benefited from the turnaround in commodities, as well as the weakening of the U.S. dollar. Also, political change in Brazil, with the impeachment of former President Dilma Rousseff, and a standoff in hostilities between Russia and Ukraine have allowed capital to flow back into these large emerging economies.
China’s stabilization has continued since February, as policymakers seem to have pulled off a relatively soft landing for its economy. Together, these dynamics have led to the substantial rally we have seen so far this year.1 2
Disciplined and Diversified
While of course we did not know that 2016 would finally be the year of the emerging-markets turnaround, we did communicate that maintaining allocations to emerging markets made sound investment sense.
Going into 2016, emerging markets were historically cheap relative to their own history and to developed markets. The long-term secular trends of growing populations and increasingly skilled and educated workforces — leading to rising incomes and purchasing power — remain fully intact.
So here we are, heading into the fourth quarter and emerging markets are leading both our equity and fixed-income programs. Sticking to the discipline and staying diversified have clearly shown merit this year.
The Education Story
Across the emerging world, literacy rates continue to rise. In 2015, 93% of the population aged 15 and older was literate versus 91% in 2010 and 88% in 2000. Additionally, 127 million people are currently pursuing a higher education, which represents a 21% increase just from 2010.
The translation from education to income is real. Between 2010 and 2015, the number of households with annual disposable income in excess of $10,000 grew by 39% to 539 million. From India to Vietnam, and from Egypt to Brazil, consumer expenditure on education has exploded over the past five years.3
Growth in Consumer Expenditure on Education in Selected Emerging Market Economies (EMES): 2010-2015
The Big Picture is Key
There are plenty of challenges in the world, from terrorist threats and interest rate uncertainty to subpar economic growth and an atypical election just two months away.
A near-term market correction should never be a surprise, but beyond the next quarter or two lies the next decade or two. There are millions and millions of people who are seeking the opportunity to learn, work and advance their standing in life. The impact will be profound, and investors can reap many rewards in the years ahead because of it.
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