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In the last 15 years, economic growth has been booming across emerging markets (EMs), with China and India generating around 10% GDP growth per year. As investments poured into these markets, investors naturally assumed that this would feed through into earnings per share (EPS) growth, the main determinant of long-term stock market returns. However, macro growth is not market growth (Figure 1).
Figure 1
The US and China are the best examples of this dynamic. China EPS growth has stagnated while US EPS growth has been exceptional, despite China’s economy growing at twice the speed of the US.
Index composition and whether underlying companies are reflective of the economy at large can drive disparities. Within the US, growth has been led by the tech sector, which comprises a lower part of the overall US economy compared to its market cap. These large- cap companies have captured more market share compared to small/unlisted companies.
When EPS is diluted by additional company share issuance, it can further exacerbate this misalignment with GDP growth, which has been a significant drag within China. Index rebalancing toward lower-earning companies has also been a factor in China’s lower market returns. Some of the largest EM ex China markets, such as Taiwan, realized outsized returns relative to GDP growth, as large companies generated most of their earnings abroad, not in the country of domicile.
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