2022 was undoubtedly a bleak year for the investment industry, and particularly our own small corner of the investment world in developing markets. Rising rates and escalating geopolitical tensions were particularly damaging for perceived riskier ‘growth’ assets, especially in emerging markets.
Arisaig’s peer set appears to be gradually shrinking, an inevitable consequence of the underperformance of emerging markets over the last decade relative to geographies perceived as politically safer.
When we look back at the last 25 years, we observe around eight emerging market drawdowns of similar magnitude. Over half of these drawdowns have taken place since our second-generation partnership team joined the firm. Hence whilst our team is familiar with volatility, the magnitude of this year’s losses places it right in the top bracket of bear markets, alongside the Global Financial Crisis in 2008, as well as the Asian Financial Crisis in 1997.
Our strategy as a business for the last year has been simply to remain intensely disciplined with regard to our investment process, resist any urge to lurch or tactically force performance, and trust that the superior fundamentals of growth will carry us through to the end of this ‘winter’ for emerging markets, enabling us to make hay in ‘spring’.
Unfortunately, we cannot predict when the proverbial spring will arrive but there are two observations that the industry has made. The first is that we are entering the twelfth year of the bear market for emerging markets relative to developed markets, and that these cycles have historically lasted about a decade – implying a turn in fortunes for emerging markets is overdue. Furthermore, these cycles tend to be highly correlated to US Dollar strength.
EM Equity Performance Relative to DM (Pink Line, Left Axis) vs US Dollar Index (Grey Line, Right Axis)
A further observation is that a US Dollar bull run tends to peak before the US Fed finishes hiking interest rates – in other words the market begins to price in a plateauing and eventual reduction in US yields long before this actually happens. The analysis below from Bloomberg asks whether we may already be seeing this turning point in US Dollar strength.
US Dollar Usually Peaks Before Rates
In terms of relative macro prospects, emerging markets are not in a bad place compared to developed markets. Our numerous field visits over the past year suggest that on-the-ground demand sentiment is also surprisingly buoyant, as detailed in these notes from India, the Philippines and Vietnam.
Looking at the state of the world in general, after three awful years characterised by the pandemic, inflation and war, there are at least some glimmers of hope ahead. Russia is losing in Ukraine, and China is not supporting the war too obviously – moreover, it seems to be subtly pushing behind the scenes for a peaceful resolution and is less subtly warning Putin against any further escalation. This reflects other recent attempts by Beijing to try to lower the temperature in terms of geopolitical tensions. It looks like many of the domestic dysfunctions of the past two years in China are starting to be reversed – a normalisation in the Chinese economy (and hence supply chains) would play a significant role in bringing global inflation back under control, with further positive (for us) implications for US interest rates and the US Dollar.
Markets move in cycles, and so we wait for Spring.
