A familiar refrain of emerging markets bulls over the past year, probably longer, has been that stocks in developing economies are less expensive than their developed market peers.
The risk with the emerging markets stocks are inexpensive thesis is that, bereft of notable earnings growth, these stocks can get even cheaper. Emerging markets stocks and exchange traded funds have not lacked for negative attention in 2015 and the fact the MSCI Emerging Markets Index trades at a low multiple has not been enough to entice investors because earnings growth in developing economies is not strong.
Tumbling commodities prices have made the Market Vectors Russia ETF (NYSEArca: RSX) and the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ) among the least expensive single-country emerging markets ETFs.
“It looks really scary to invest in places like China and Russia and Brazil. But that’s where the bargains are … Diversified value stock portfolios are trading at Shiller P/E multiples of eight times. That is the kind of opportunity that provides high future, long-term real returns … After inflation, we would expect 6 percent to seven percent real returns from emerging markets. That contrasts with one or two percent real returns from U.S. equities,” according to a note from Research Affiliates posted by Dimitra DeFotis of Barron’s.
However, for now, many investors are cutting their losses as outflows from emerging markets ETFs continue at a blistering pace. Developing world equities have to contend with plunging currencies, slack commodities demand and stumbling stocks in China, the largest emerging market. [Emerging Markets ETFs Keep Bleeding Assets]
Nevertheless, more intrepid investors may target some of the cheapest emerging markets. For instance, Russia is currently the cheapest on absolute terms, with a forward P/E ratio for the MSCI Russia Index at 4.9, compared to its 5-year average of 5.2, according to Capital Economics.
Emerging markets have been pummeled in recent weeks on the weakening outlook for growth and currencies, notably as China’s economy shows signs of slowing down. Additionally, developing markets are also bracing for the eventual Federal Reserve interest rate hike, which could cause greater outflows from the riskier emerging markets.
Investors should look at the emerging market equities as a more cyclical asset. Currently, after years of out-performance in the developed markets, the emerging markets are beginning to show a lower premium to more developed countries. [Look to Emerging Market ETFs in the Second Half]
Market Vectors Russia ETF