For the most part, emerging market (EM) stocks have been having a good year.
Investors have flocked to developing markets lately amid continued low U.S. interest rates and hopes of further economic stimulus from emerging world central banks.
EM equities are up about 10% year to date, as measured by the MSCI Emerging Markets Index, and have outperformed stocks in the S&P 500 Index, the MSCI ACWI Index and the MSCI EAFE Index (source: MSCI, Bloomberg as of 4/24/2015). Flows have been following this outperformance. According to BlackRock fund flow data, U.S. listed EM Exchange-Traded Product (ETP) fund flows are up roughly $3 billion this year, as compared with total inflows of only $3.6 billion in all of 2014 (source: BlackRock, Bloomberg as of 4/23/15).
Given this strong performance, it’s not surprising that many market watchers are wondering whether it’s too late to invest in emerging markets. Even after the recent rally, it may still be an attractive entry point for investors who have been sitting on the EM sidelines. Here are three reasons why.
1. Compelling valuations.
Despite their outperformance year to date, EM equities remain attractively valued compared to their historical valuations and to the valuations of their developed market counterparts. For instance, as measured by price-to-earnings (P/E) and price-to-book (P/B) valuations metrics, EM stocks continue to trade at a roughly 30% discount to the broader global equity market (source: MSCI, as of 3/31/2015). In addition, unlike U.S. equities, EM stocks are still off 6% from their peak in 2007, meaning they still potentially have room to run (source: MSCI, as of 4/24/2015).
2. Signs of economic improvement ahead.
While economic data out of major EMs has certainly been disappointing lately, many EM central banks continue to conduct monetary stimulus policies geared at helping their economies grow. For example, central banks in China and India have recently implemented rate cuts. Meanwhile, a number of EM governments are implementing reforms that could help spur growth, and lower and stable oil prices may benefit oil importers in the emerging world.
Finally, according to BlackRock funds data, net flows into emerging market ETFs have turned positive recently, as more and more investors seem to be noticing the potential opportunities there (source: BlackRock, Bloomberg as of 4/23/15). Given that many U.S. investors are underweight EMs in their equity portfolios, a renewed interest in this part of the world could be a potential tailwind for the EM asset class (source: Bloomberg, as of 1/22/15).
To be sure, investing in emerging markets can be risky, not least because these markets can be volatile. Even amid the 2015 rally, we have seen some isolated volatility within the EM space, thanks partly to the surge in the U.S. dollar.
Still, the EM asset class remains an important component of a diversified portfolio. So how can you potentially gain exposure to EMs? Investors may want to consider a selective approach to EM equities given that performance results have varied widely by country.