Portfolio Discussions: Emerging markets
Economic growth in emerging markets (EM) has been almost double that of developed markets (DM) over the past decade. But in recent years, a steep decline in commodity prices and volatile currencies left emerging markets under pressure. These forces have largely stabilized, suggesting that the rebound in EM assets should be able to continue. Nevertheless, investors should look to actively differentiate within the asset class to capture opportunities and avoid pitfalls.
Emerging market equities have gotten a lot cheaper
- Across the main regions, emerging market equity valuations are the most attractive relative to their history. The price-to-book ratio for EM equities is right around its long-run average.
- Combined with this attractive valuation is the prospect for a turnaround in EM earnings after years of painful adjustments. This would provide a catalyst for a more sustainable rebound in the asset class.
- However, investing in EM still requires a selective approach, as the economic, earnings, and valuation picture for regions and individual countries can vary greatly.
Broad EM turnaround depends on improvement in growth alpha
- Since 2010, EM equities have been under pressure compared to developed market equities, reflecting the narrowing of the gap between EM and Developed Market (DM) growth.
- This was due to a tough external environment, such as a changing and slowing Chinese economy, falling commodity prices and depreciating EM currencies. These factors seem to be broadly stabilizing, allowing for an improvement in the EM growth outlook.
- As a result, a rebound in the earnings outlook for the major EM regions is taking hold.
Not the same EM
- The prospect of higher U.S. growth and inflation over the next few years has put pressure on U.S. yields and the U.S. dollar, renewing concerns about stability in EM.
- Investors should remember that EM is now in a much better position to deal with these twin headwinds, particularly relative to a few years ago.
- EM currencies have depreciated significantly against the U.S. dollar and the most vulnerable EM countries have significantly improved their current account deficits, making them less exposed to capital outflows.
- EM economic growth declined over the past few years due to pressure from lower commodity prices and a strong U.S. dollar. With more stability in these external variables, EM growth may continue to improve.
- This suggests that the rebound in EM assets may just be beginning to take hold, especially for EM equities given cheap valuations and an improving earnings outlook.
- Nevertheless, investors should expect a bumpy ride from this historically volatile asset class, and should make sure to differentiate within the EM space as not all EM countries and companies will be able to successfully navigate the new environment.
Focusing on different asset classes or regions, Portfolio Discussions help to frame investment conversations using slides from the Guide to the Markets.
International investing bears greater risk due to social, economic, regulatory and political instability in countries in "emerging markets." This makes emerging market securities more volatile and less liquid developed market securities.
Changes in exchange rates and differences in accounting and taxation policies outside the U.S. can also affect returns.
The prices of equity securities are sensitive to a wide range of factors, from economic to company-specific news, and can fluctuate rapidly and unpredictably, causing an investment to decrease in value.
Diversification does not guarantee investment returns and does not eliminate the risk of loss. Diversification among investment options and asset classes may help to reduce overall volatility.