DM and EM equity market differences and commonality

The Norwegian Ministry of a Finance commissioned a study of global equity markets from MSCI, “Selected Geographical Issues in the Global Listed Equity Market”. This exhaustive research study on global equity markets could be better called, “The differences between developed and emerging equity markets”. This is valuable reading for understanding the return differences and similarities between developed and emerging markets.

The world is becoming more global and emerging markets are a more important part of equity markets, yet their representation is still lower than market capitalization and GDP would suggest. Investors need to have an EM opinion and have to think about global economic impacts on equity valuations. Trade wars have had a significant impact on equities because more global corporate sales comes from outside a stock's home country.

Returns are higher in EM markets but so are volatilities. Emerging markets are more diverse than developed markets. EM equities will be correlated with common factors like a financial crisis, but if an investor wants more diversification benefit, it will come from holding EM markets and not diversifying across DM markets.

The world equity markets can be divided into regions include North America, EMEA, the Pacific, and EM. These regions will show common return performance dominated by their largest country equity market. Still, market fundamentals, whether price to book, price to earnings, dividend yield, or return on equity, will generally move together. 

The EM sector is getting larger for two reasons, economic growth in EM countries have been increasing relative to DM so EM represent a greater share of global GDP and the fact that more countries and names are being added to the EM index. EM markets are more sensitive to economic growth especially with respect to the downside. There is a similar pattern of sensitivity of DM and EM markets to inflation.

EM stocks are also more sensitive to currency changes. The increase in the dollar has been an important drag on EM overall returns. The currency impact on DM equities is far less dramatic. It is necessary to have a currency view when investing with EM equities.

The equity risk premium is actually well-defined across countries with liquidity, governance, and size having additional impact on explaining this risk premia.

To be an effective global equity investor, someone needs to understand the similarities and differences across geographical regions, as well as between DM and EM markets. There is much commonality which leads to high correlations, but there are also enough differences to have it worth holding a diversified global equity basket.