Why Does Volatility Often Lead to Strong Emerging Equity Returns?

Understanding the Fear Factor

In fact, the EM index has rallied by 18.4% since the market bottomed on April 9, following severe volatility triggered by Trump’s sweeping tariff announcements a week earlier. This is not entirely surprising, in our view, because history suggests that EM stocks have performed relatively well after spikes in market turbulence.

The VIX Index, an index of US equity market volatility, is widely known as the fear index. We looked at market returns after different month-end VIX levels since December 2000. Extreme VIX readings are uncommon; the index only exceeded 40 nine times at month-end during the 24-year period surveyed above.

When the VIX ended the month between 40 and 50—indicating heightened anxiety—EM stocks returned more than 64% in the subsequent 12-month period on average, well ahead of developed-market (DM) stocks. At even more volatile moments, when the VIX breached 50, EM stocks performed even better over the next 12 months, delivering a 69.2% return on average and widening the gap with their DM counterparts, which returned 34.7%.

It sounds counterintuitive, especially since EM stocks are generally perceived to be riskier than their DM counterparts. So how can we explain this observation? In our view, it comes down to market psychology. Markets often overreact to negative news and bad news gets priced in. When the VIX touches extremely high levels, we think it indicates that investors fear the worst. Yet often, the future turns out better than worst-case scenarios.

What’s Next?

This year, the fear factor is being driven by real uncertainties as investors struggle to price in the macro and micro impacts of tariffs on economies and companies. Near-daily changes to Trump’s policy decisions make it particularly hard for companies and equity investors to forecast earnings. A recession is possible, and tariffs could go higher.

In recent weeks, the extreme level of risk has receded given the de-escalation in the trade war. However, we think April’s volatility spike underscores the importance of sticking to a long-term game plan and understanding when to lean against the wind. For the same reasons that leaning into the April uncertainty was profitable, we believe that the prospects for EM equities—which are still under-owned—are being underestimated today.

Nobody can say how the trade war will play out. If it expands, there could be effects that we haven’t seen in our lifetimes as professional investors. Yet we do know that it’s almost impossible to time market inflection points and staying invested increases the chances of long-term success. Investors in EM strategies that target companies with strong fundamentals and the ability to withstand tariff pressures could be rewarded for their patience and perseverance when the dust eventually settles.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.

The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

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