Emerging Markets (EM) are about to enter a period of out-performance versus Developed Markets (DM) that will likely last for about 5 to 10 years, with 2019 being the year of transition between secular relative bear to secular relative bull.
EM equities move in a cyclical nature with rather long periods of out-performance and under-performance dominating. Historically, these periods have lasted for multiple years and there is good reason to believe that such a pattern will repeat.
Chart 1: Emerging Markets Equity Index divided by Nasdaq Index, monthly January 1975 to November 2018
Emerging Markets Equity Index divided by Nasdaq Index
EM has plainly struggled against the Nasdaq, which is a good proxy for the strongest element of DM equities. From its previous peak in 2008, our EM Index has had difficulty gaining any traction and has just tested its all-time relative low zone versus the Nasdaq.
Previous lows were disasters for emerging economies in general. The early 80s low saw difficult recessions in many DMs and a collapse in the price of commodities — a toxic mix for EM. The next major low in Chart 1 during the late 90s saw EM currency crises, the culmination of a long-term commodities bear, and a tech bubble which absorbed much of the excess global investment capital — again a toxic mix for EM.
Today, there are similar conditions which could similarly invert. Commodities have been generally weak for a decade, tech has been in a ragging bull for much of the same period, and emerging economies are generally seen as having lost their luster.
Zettacap’s models forecast an inversion and, as can be seen in the above chart, the risk / reward seems extremely interesting at present. In an apparent worst-case-scenario, EM looks to tread water as little relative downside seems likely. An apparent best-case-scenario puts EM out-performing the NDX by a factor of 4 to 5 times over approximately the next decade — such an opportunity is rare and worth a closer look.