Emerging markets have long borne the really-risky mantle. They can be more volatile and cyclical than some investors are comfortable with. These nations offer nice returns, or promises of them. After all, unlike the developed world, they have a lot of room to climb.
Trouble is, sometimes the enthusiasm for them grows too large. Whether through over-borrowing, under-capitalized companies, local political meddling, they and their stock markets might come to grief.
That’s the lesson from the 1997-98 Asian Contagion, a mess that started in Thailand and spread throughout the region. Some Asian nations saw their markets drop by 40% or more. Stockholders worldwide suffered from the slide. Fortunately, the International Monetary Fund came to the rescue.
Well, that imbroglio was a quarter-century ago. And lately, a lot of smart investors are getting into EMs, often through exchange-traded funds that track the MSCI Emerging Market Index, or others like it. This year through last Friday, amid questions about the U.S. economy and trade policy, the index jumped 27%, twice that of the U.S.-standard S&P 500. One added bonus is that, despite the runup, the EM index is cheaper than big-time stocks: It’s price-earnings ratio of 15 is a nice discount to the S&P 500’s 25.
The appreciation advantage is recent, though, a testament to the fluctuating nature of EM stocks. Over 10 years, the U.S. benchmark was ahead 13% annually, surpassing EMs’ 8%. To be sure, small countries are more susceptible to globe-spanning forces, not to mention weather and political upheavals. (We’ll leave that latter point for later discussion.)
One thing to know, and this is kind of reassuring: Sizable economies dominate the EEM index. Meaning they are presumably less subject to collapse than, say, a small South American nation. China has the highest index weighting at 30%, followed by Taiwan 19% and India at 16%. Their EM status has a lot to do with how emerging nations are designated. High levels or poverty, such as in China and India, is a big factor in the EM categorizing.
Adam Turnquist, chief technical strategist for LPL Financial, is optimistic about EMs. As he sums up, in a research note, several catalysts are propelling EM outperformance lately: “a weaker dollar, attractive relative valuations, solid earnings growth, easing financial conditions and significant stimulus aimed at sparking a recovery in China.”
Let’s focus on the weaker dollar. According to the DXY dollar index, the buck is off almost 10% this year versus a basket of other currencies. That whittles down a heady increase that the dollar has enjoyed this decade.
Fear of continued U.S. inflation and President Donald Trump’s trade policies are the likeliest culprits. A dwindling dollar can entice investors to warm to better returns in what used to be called the Third World. Further, a lot of EMs are heavily into commodities, whose prices benefit from a cheaper buck as many raw materials are valued in dollars.
In a recent report AllianceBernstein advised: “With U.S. exceptionalism under more scrutiny, we think investors should reevaluate their overweight to U.S.-dollar-based assets.”