After years of trailing the US in a key measure of corporate profitability, companies in emerging markets (EMs) are showing signs of meaningful improvement in capital efficiency. The chart above shows return on invested capital (ROIC) across regions and reveals a steady upward trend in EMs over the past year. The US still leads but the gap has narrowed, especially when adjusting for the outsized impact of the “Magnificent Seven” tech stocks.
The capital return in EMs has consistently lagged the US over the past decade, a gap often cited as a reason to steer clear of EM equities. As seen in the chart above, however, taking out the Magnificent Seven reveals that EM is now roughly on par with the rest of the US market. This underscores the progress EM companies have made in deploying capital more effectively.
Much of the recent improvement has come from China, which has recovered from the wave of regulatory crackdowns four or five years ago that dented profitability in a host of key industries. The chart below comparing ROIC between MSCI EM and MSCI China highlights China’s recovery. Recent policy efforts have focused on curbing irrational competition—what officials call “involution”—and improving capital allocation. Reforms aimed at strengthening corporate governance, boosting shareholder returns, and raising listing standards are also beginning to bear fruit. Taken together, these initiatives should gradually support better capital allocation across the economy. And we’re already seeing early signs of supply rationalization in areas such as lithium and other resources-based industries. ∎
