Overwhelmingly positive COVID-19 vaccine data from Pfizer stands as a much-needed reminder that there is a future after this Groundhog Day hamster wheel we are all enduring. At some point, many of the hallmarks of 2020—virtual happy hours, 100% work from home, and even masks—will go by the wayside. However, the signal and enduring change that the pandemic has brought is a remarkable acceleration of societal digitization across the globe. No area of the world has moved faster or is poised to benefit more from this digital ascension than are emerging markets, in our view. For the reasons we describe here and in more detail in our 2021 Capital Markets Forecast, Wilmington Trust has recently moved to an overweight in equities with a relative concentration in emerging markets.
Demographic-driven secular growth has powered emerging markets economies for decades. In more recent years, these developing countries—particularly those in Asia—have positioned themselves as leaders in the digital revolution on the supply and demand side of the equation. Consumers in China—the largest component of the MSCI Emerging Markets Index at over 43%—and the surrounding regions are years ahead of the U.S. in some areas of technological adoption, including contactless payments, facial recognition software, and even e-retail. Companies based in the region that predominantly serve Chinese consumers are also ahead of U.S.-domiciled corporations in terms of integrating these technologies into their advertising, manufacturing, and distribution models to maximize productivity and profitability.
Why now? First, emerging markets equities have lagged U.S. large cap by nearly 9% annualized over the last three years and now trade at historical discounts to their U.S counterparts. The ratio of S&P 500 technology vs. emerging markets technology stocks' price-to-earnings ratios is in the 96th percentile of daily observations going back to 2006.
Second is the expected thawing in the U.S.-China trade spat has been an overhang on emerging markets valuations for two years. We do not expect the new administration to be soft on the Chinese but we do expect a less commercially tough engagement, with perhaps less tariffs and more multilateralism.
Third, supply change disruption occasioned by both trade tensions and the pandemic have set in motion supply chain rethinks for many multinational companies. On the one hand this will benefit second-tier sourcing countries such as Vietnam, India, and Indonesia while on the other, China will be just fine as it continues to pivot an economy driven more by services and ever-increasing domestic consumption. Last, emerging markets equities tend to benefit when the U.S. dollar weakens, and conditions are setting up for a continued weakening of the dollar over the next 12 months. A highly effective vaccine that leads to a resurgence of global activity should weaken the dollar, in our view, given the U.S. dollar typically acts as a counter-cyclical currency (weakening when global growth accelerates). A dovish Fed on the sidelines and high levels of pandemic-related spending could also contribute to dollar depreciation, particularly since recent dollar weakness has only returned the trade-weighted dollar to early 2020 levels.
What lies ahead? As the recovery continues, we expect to experience periodic global rotations into cyclicals as we have this week. But for investors playing the long game, no equity region stands to benefit from the recent digital acceleration as do emerging markets and we believe this trend will continue for years to come.
 Reflects the ratio of price-to-earnings ratios based on 12-month forward estimates of earnings for the S&P 500 technology sector vs MSCI emerging markets technology sector.