Do Rising Rates Mean Lower Returns for EM Equities?

July 19, 2018

Rising rate environments are typically thought to put downward pressure on equity returns. Specifically for emerging market (“EM”) equities, the common perception is that higher interest rates in the United States will drive EM returns lower and investors away from EM securities. However, in looking at the annualized returns of the MSCI Emerging Markets Index over historical periods of rising rates, this may not be the case.

This week’s chart of the week shows the annualized return of the MSCI Emerging Markets Index in rising rate environments and the Fed Funds Rate at the start and end of those periods. Only one of the time periods — January 1994 to February 1995 — was negative, and the average return for the time periods examined is 14%. In the most recent period — from December 2015 through June 2018 — the MSCI Emerging Markets Index has returned over 11% annually. Contrary to common belief, in periods when rates are rising, EM equities seem to perform well.

What explains this performance? For one, economic fundamentals for EM economies have been strong. The annual real growth rate of GDP for developed markets has averaged 1.9% over the past 5 years, while the same measure for emerging markets has averaged 4.9%. The more recent poor EM performance is mostly due to an appreciating dollar, which makes exports from EM countries cheaper to purchase in the U.S. Longer term, however, the data suggests that EM returns could be positive as rates climb higher in the U.S.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.