By Brett Arends, MarketWatch
Investors don’t need to be reminded of the risks of emerging market stocks. Least of all now.
Prices are volatile. Corporate governance can be sketchy. The political systems are often unstable, and the news can be downright scary. And emerging market stocks have underperformed their U.S. counterparts for a long, long time.
In the past 10 years, the SPDR S&P 500 exchange traded fund /zigman2/quotes/209901640/composite SPY +1.39% , which mirrors the benchmark S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.38% of the largest U.S. stocks, has produced total gains of 290%. Vanguard’s FTSE Emerging Markets exchange traded fund /zigman2/quotes/204649024/composite VWO +1.13% over the same period: 80%. The iShares Emerging Markets ETF /zigman2/quotes/201454250/composite EEM +1.11% : Just 68%. Ouch.
Throw in President Trump’s threat of a trade war and the future looks pretty bleak. China’s Shanghai Composite tanked more than 5% Monday.
So what’s to like?
Try five reasons to consider the road less traveled.
1. The long underperformance has left emerging markets at historic relative lows. A chart that tracks the MSCI Emerging Markets Index against the S&P 500 shows emerging is now down around levels seen in 2004. And the main emerging index is flattered by a few big and stable multinationals, such as Samsung /zigman2/quotes/202367843/composite SSNLF +30.66% . A different measure, which weighs a broad basket of stocks equally, suggests emerging markets are now back in relative terms to where they were right after 9/11. No kidding. These are generational lows. And when they were pummeled by fears of global terrorism back then, they were still struggling to recover from a disastrous economic collapse a few years earlier. There is no comparable double-whammy now.
2. Valuations are low. Analysts at Germany’s StarCapital rate emerging market stalwarts Russia and China as the best bargains among the world’s stock markets, with Greece, Turkey and Korea also in the top 10. Extensive academic research has found that investing in the world’s cheapest stock markets every year has produced fantastic results over the long term. And some big, if contrarian, names are bullish. Newport Beach, Calif.-based institutional investment adviser Research Affiliates and Boston fund company GMO both see emerging markets outperforming the U.S. and other developed markets by a country mile over the next decade. Both firms think value-oriented investors, picking stocks based on fundamentals such as current sales and earnings, could double their money in emerging markets over the next decade.
3. Emerging markets are a portfolio diversifier. This can be an underappreciated point. We don’t know what the future holds. But because emerging markets dance to a different tune, they can sometimes save you when mainstream, developed markets let you down. That’s what happened between 2000 and 2010, when U.S. stocks went nowhere while emerging markets more than doubled. And it’s what happened, for example, during the big bear market for developed markets in the 1970s. Someone who’d stuck to U.S. stocks lost money. Meanwhile, the emerging markets of the era — Japan, Singapore and Hong Kong — went up three-, four- and five-fold.
4. Yes, they’re volatile — that’s the point. The general rule of stock markets everywhere is that they’ve been great bargains when they’ve been down and nobody wanted them, and less good when they’re up and everyone is buying. For emerging markets, that’s been even more dramatically true. They crashed in 1998, 2001, 2003, 2009 and 2016. All proved terrific buying opportunities, and fast. Within 12 months, the average bounce from the lows was 70%. None of that is guaranteed this time around, but if the past is no guide to the future than all bets are off anyway.
5. You probably own too little. Based on exchange traded fund data from the Investment Company Institute, U.S. investors overall have just 6% of their money in emerging market funds. For many, the number is probably zero. And conventional wisdom among financial advisers, covering their own risks, warns investors against going above 10%.
Emerging markets’ share of the global economy? Try 40%. It’s doubled in a generation. And they are growing far faster than the developed world. By 2024, says the International Monetary Fund, emerging and developing countries will have a greater economic output than the rich countries of the G7. Twenty years ago, they were just a third the size of their richer counterparts. Among other things, the rapid growth of emerging economies also suggests they are a lot less vulnerable to U.S. trade threats than they used to be.
Brett Arends is a columnist for MarketWatch.