Blog Posts — July 16, 2020

Emerging Markets lag China in equity-market gains, but also risk

by Diana R. Baechle, PhD

China’s weight may dominate Emerging Markets, but returns and risks have gone their own way. Emerging Markets in aggregate have not mirrored China’s recent equity-market gains. And while China’s risk has spiked, Emerging Markets’ risk has continued to fall.

Chinese stocks rallied as Emerging Markets failed to report YTD gains

Chinese stocks rallied for eight days (between July 1 to July 9), lifting China’s market 16% (in local currency), as Chinese shares were boosted by the prospect of a recovering economy. Chinese equity-market returns denominated in US dollars were even higher than those in the Chinese yuan. That is, US investors benefited even more from China’s rally than local investrors due to the FX rate. China posted a gain of 18% in US dollars (vs. 16% in Chinese yuan) for the July 1 – July 9 period, while the year-to-date return was also one percentage point higher than that in the domestic currency. And whereas risk in the Chinese yuan rose 10 percentage points this year, US dollar-denominated risk was up less, especially in the recent period.

Source: FTSE Russell, Qontigo

But the broader Emerging Markets index only saw cumulative gains of 10% (denominated in US dollars) between July 1 and July 9, and year to date the Emerging Markets index return was slightly negative, compared with a 16% gain in China.

The Chinese CSI 300 index was the only major benchmark to report a positive cumulative year-to-date return as of June 10. Despite a strong recovery since April, FTSE Emerging Markets did not make it into positive territory for the year, recording a year-to-date cumulative return of -3% by the end of last week. This discrepancy in returns was surprising, since China represents almost 50% of the FTSE Emerging index.

Source: FTSE Russell, Qontigo

Emerging Markets’ losses driven by Style and Currency factors

When delving into Emerging Markets’ negative cumulative year-to-date return, the Style and Currency factors drove the fall in emerging stocks. More specifically, positive exposures to Market Sensitivity, Size and Short-Term Momentum, and negative exposure to Volatility, provided for the largest negative style factor contributions to Emerging Markets’ losses. In terms of currencies, the Brazilian real, South African rand, Mexican peso, and the Russian ruble were the main detractors. The Chinese yuan had a negligible impact (-0.02%).

All other factors—Specific Return, Country, Industry, Local and Market—had positive effects on Emerging Markets, mitigating the overall year-to-date loss for Emerging Markets.

Source: FTSE Russell, Qontigo

Half of China’s positive effect offset by LATAM

Individual countries had mixed effects on the aggregate Emerging Markets index, some positive and some negative, but except for China and Brazil, each emerging country’s impact was relatively small. A large portion of China’s positive contribution (5.5%) was countered by Brazil’s negative contribution (-2%). Latin America offset half of China’s positive impact on Emerging Markets’ year-to-date return. In the chart below, emerging countries are aggregated by region to illustrate China’s tremendous impact, even compared with entire regions (which is not surprising given that it is almost half the index).

Source: FTSE Russell, Qontigo

Declining stock correlations drove down Emerging Markets risk in July

China’s risk spiked in July, while Emerging Markets’ risk only saw a blip in its otherwise downward trajectory, as measured by Axioma’s China and Emerging Markets models, respectively. The short-horizon fundamental forecast of Axioma’s China model has jumped close to 740 basis points since the end of June, nearing March highs. China’s volatility surge was caused by a rise in both stock volatility and correlations.

When run through the lens of Axioma’s fundamental short-horizon Emerging Markets model, and in US dollars, China’s risk still increased, but less so (about 300 basis points) since June. However, there was little difference between the Emerging Markets model’s risk forecast for China (of 25.1%) and the China model’s risk forecast (of 25.8%) on June 10.

In contrast, Emerging Markets’ risk dropped 30 basis points in July, as measured by Axioma’s Emerging Markets short-horizon fundamental model. While stocks’ volatility in the Emerging index also increased, the decline in stock correlation more than offset the rise in stock volatility, resulting in a decline of Emerging Markets’ risk.

The drop in Emerging Markets’ risk occurred despite China’s dominance

The decline in Emerging Markets’ risk occurred despite China’s 44% contribution to the benchmarks risk (which is notably less than its weight). The dispersion among emerging market countries’ returns (in US dollars) widened in 2020, compared with the end of 2019, and the correlations between them declined, leading to a decrease in aggregate emerging market risk, despite China’s dominance in the index.

Source: FTSE Russell, Qontigo

Emerging Markets becomes second least-risky region

Year to date, China had maintained its status as the least risky country across all geographies Axioma tracks closely for most of 2020. But as other regions across the globe started to see risk fall more recently, last week’s jump pushed China to somewhere in the middle of the pack. At the same time, Emerging Markets became the second least-risky region after Japan.

*Note: The risk models used are the most local available. For example, the China forecast is based on China model, the FTSE Emerging is based on the Emerging Markets model, etc. Most benchmark risks are calculated in home currencies, with the FTSE Developed, FTSE Developed Europe, FTSE Emerging, FTSE Asia Pacific ex-Japan in USD.

Source: FTSE Russell, Qontigo


Chinese stocks rallied in July, while Emerging Markets failed to enter positive territory for the year, driven down by the Style and Currency factors. Half of China’s positive effect on Emerging Markets’ aggregate year-to-date return was offset by LATAM (mainly by Brazil).

As China’s risk climbed, a drop in stock correlations drove down Emerging Markets’ risk in July. The decrease in Emerging Markets’ risk occurred despite China’s dominance in the benchmark.

For now, the diversification driven by lower correlations—between other emerging countries and China, and other countries versus each other—means Emerging Markets still represent a lower risk investment than most other major regions, including Developed Markets, but the environment could quickly change in the face of a second-wave of the coronavirus pandemic.

What we are seeing is not, obviously, the norm and well-built risk models can help investors distinguish temporary changes from emerging trends, and thus be better prepared to manage their risk.