In these bullish times, emerging markets (EMs) have been the stars. We’ve now had 18 months of sustained outperformance, in which the MSCI EM index has dominated the world index, delivering a 47% return, or 23% better than the US-heavy world index.
Over that same period the JSE delivered a 32% return, still comfortably ahead of the world index. But on a longer view, South Africa has been an outperformer for much of the post-Covid period, beating both the world and the EM indices.
This is during a period when market hype has been dominated by AI. Such stocks as Nvidia and Meta, Microsoft and Alphabet have grabbed the headlines. But while they’ve certainly been big upside contributors to the global index, EMs have quietly been outperforming on average.
For much of the past 15 years, EMs have been treated as one exotic, undifferentiated risk trade — bought and sold as a block whenever investors turned “risk on” or “risk off”. It wasn’t always this way. Before the 2008 financial crisis, which hit developing markets hardest, pundits such as the late Mark Mobius, then at Franklin Templeton, and Jim O’Neill, then at Goldman Sachs, had argued that a deep structural shift would drive EM outperformance for the long run. The crisis buried that thesis for a decade. Now the differentiation is back.
So, what changed?
South African Reserve Bank governor Lesetja Kganyago gave a speech last week that helps to explain it. He points out that several big EMs, such as Brazil, India, Indonesia, Mexico, Thailand and South Africa, have become far more resilient. He puts that down to institutional improvements. Compared with 2008, and previous crises such as that of 1998, EMs have moved far from the “original sin” of pegging currencies and borrowing in foreign currency. At the first whiff of trouble, foreign capital would leave and central banks would blow their reserves trying to protect the currency, eventually giving up and creating a shock devaluation that would be followed by high interest rates. That is close to what happened to South Africa in 1998 and is definitely the story of many Southeast Asian and other African markets at the time.
Exchange rates now float and reflect genuine market views on risks. There are also far bigger stockpiles of foreign reserves (though, ironically, they are needed less), and better supervision of domestic financial sectors. The governor points to central bank independence and inflation targeting as being among the clear institutional developments that mark this change. Of course he is talking his own book, but it is certainly true that central banks in many large EMs now operate transparent and independent monetary policy, and that has brought stability. Notably, his list excludes China, Türkiye and Pakistan, which haven’t managed comparable institutional gains, but others could be added to his list like the Philippines, Korea and Chile.
Of course, we must be wary about connecting stock market performance to institutional strength. Share prices should be nothing more than the present value of future cash flows, discounted for risk, and those can be affected by completely different factors such as commodity price cycles and broader economic growth. But the institutional change that Kganyago points to focuses on the risk side of the present value equation.
The data backs up the risk story. The traditional reputation EMs have had for boom-and-bust cycles, made worse by the response from volatile and weak institutions, appears to be a distant memory. Investors appear to be factoring in reduced risk for exposure to these markets as a result. EM indices show less volatility than they did historically and, for long periods, less than global indices. South Africa has been a particularly clear example.
It helps, too, that developed markets haven’t looked quite so stable themselves. The perception of EM robustness has been enhanced by US President Donald Trump’s attack on Federal Reserve independence and the astounding and continuing volatility on tariffs and other key economic policies. That has made investors feel that developed markets are not the bastions of institutional stability they were always assumed to be. In contrast, EMs are going in the right direction.
So how should South Africa-based investors think about what could happen next? To my mind, the only way to answer that question is to look at the fundamentals. The indicators all show South Africa is undervalued. Local stocks boast an earnings yield of 11.7%, while the EM and world indices show 10.1% and 6%. Dividend yields are even starker — South Africa earns you 5.1% vs 2.6% for the EM index and a paltry 1.8% for the world index. From that perspective, South Africa clearly remains in value territory.
Kganyago’s point, though, is narrower than O’Neill’s original growth story: the change has been institutional, not economic. Fiscal policy hasn’t managed the same improvement in transparency and predictability — our own blowout in debt from 30% to 80% of GDP since 2008 is stark — and growth, particularly in South Africa, hasn’t kept up. But what we have seen is a deep and meaningful change in the risk profile of EMs. Get the growth story right, and the upside would be substantial.
Theobald is chair of research-led consulting firm Krutham
