After a thorough ravaging of the emerging market equities, audacious investors may be intrigued by the prospect of a rewarding long-term investment that comes with a “half-off sale” in exchange traded funds (ETFs).

The emerging market equities asset class is offering attractive long-term risk premiums, write Rob Arnott and John West for IndexUniverse. It is noted that the asset class is cheap on both absolute terms and in relation to U.S. equities.

Long-term returns come from income, growth in income, and change in valuation. Because of higher economic growth rates in developing countries, it is reasonable to expect that emerging market countrieshave higher earnings than stocks of developed countries.

But there is a caveat with potentially higher earnings. Emerging markets are more inefficient because of “noise” or contagions, defaults, political crises and bubbles in a developing country’s market.

Because of their boom-and-bust cycles, emerging markets suffer mispricing which leads to cap-weighted indexes for large positions in overpriced stocks and smaller positions in underpriced stocks. So the prudent investor will need to find the balance between price and portfolio weight.

A savvy investor will gather bargains for the long-term investment, say Arnott and West, such as current emerging market stocks, and place them in a diversified portfolio consistent with one’s time horizon and risk tolerance.

For our own part, we’ll continue to use an entry strategy implementing the 50-day moving average.

Most funds are far below the 200-day moving average, meaning it would be a long wait before a signal to buy is reached. We haven’t been so far below the long-term trend lines in decades. As a result, we have a short-term plan for getting back into the markets if the rebound is real:

• When a fund crosses above its 50-day moving average, put 25% of the value of your portfolio.
• When the fund goes up 5%, put another 25% in.

By the time this happens, the 200-day moving average should be well within sight, and things should begin operating in line with our normal buy parameters once again.

Tags: Emerging Markets