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Extract from our "Emerging Markets = China + EM ex China" research paper, published 12th February 2021

Aggregation is often used as an efficient shortcut to help investors think about market segments. But we find the term ‘EM’ increasingly problematic, because of the stark divergence between China and the rest of EM.

1. We believe investors should be suspicious of EM aggregate figures, and try, instead, to split China out from the category. ‘BRIC’, for example, is one of the most misleading terms used in the vernacular of finance in recent years, in our view, as the four countries are much more different than they are similar.

2. After initially rising with China during the first decade of Globalisation 1.0, which began in 2001 with the inclusion of China in the WTO as a full member, EM excluding China has seriously under-performed much of the rest of the world in many ways in the past decade. Their dollar GDP, in fact, has seen zero growth in the past 12 years: something is seriously wrong with EM ex-China. But for reasons we don’t fully understand, this significant under-performance of EM ex-China does not seem to be a well-advertised fact.

3. Parts of EM ex-China have not seen much build-up of their capital stock in the last generation, falling behind the powerful trends seen in Asia in the past years.

4. We believe this lack of ‘growth alpha’ in some EM ex-China economies is problematic, particularly because the on-going structural reforms in China will likely further weaken the ‘growth beta’ on which these economies have relied in the past years. This lack of growth alpha and weakened growth beta could mean more acute reactions to changes in global liquidity conditions, i.e., ‘Taper Tantrums’ could be increasingly violent.

Bottom Line

The prevalent narrative on EM is a decade out of date. Yet, the popular narratives about EM continue to lump China together with the rest of EM. Aggregate data for EM on economic growth, capital flows, bond and equity market performances, and trade significantly flatter the picture for EM ex-China because of China’s inclusion. The misdirection of the term ‘BRIC’ continues with the rather careless use of the term ‘EM.’ China has changed so much over the years that, we believe, investors should think about EM ex-China. Admittedly, this note points out the obvious, that EM ex-China as a group has under-performed its own past, China, and its reputation. It is no longer true that EM ex-China ‘grows so much faster than DM’ and such a notion should not be presumed to be so going forward. In thinking about why the past Taper Tantrums were so disruptive for EM, one needs to consider the fundamentals of EM too weakened to retain international capital. For investors, it will be much more important to differentiate between the economies in EM ex-China.

Extract from "Emerging Markets = China + EM ex China", published 12th February 2021

Sections included within this report are:

  • The need to split out China from the rest of EM
  • A low stock of capital
  • China is surging ahead as an exporter, leaving the rest of EM behind
  • Growth alpha versus growth beta and ‘push’ and ‘pull’ capital

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