Not Time to Abandon the Strategy
Pick your poison on what has caused the international stock markets to experience the current correction. A rising dollar and increasing interest rates, combined with the tit-for-tat trade/tariff tantrum between the Trump administration and US trading partners have not been kind to overseas markets. Emerging market stock prices are down over 15% from 2018 highs (MSCI EM index). Is now the time to abandon the asset class? We say no.
Fundamentals: Economic growth estimates by the IMF continue to be positive. Developing Asia GDP is estimated by the IMF to grow at 6.5% through 2019 which accounts for half of world growth. A key driver of stock prices, corporate earnings growth, is also well above average. Earnings for emerging markets are estimated to increase 23.8% year over year (Factset). Looking out to mid & late 2019, growth will likely slow, but an economic or earnings recession is unlikely.
Valuations: On a cyclically adjusted price to earnings ratio, emerging market equities are trading at less than half the level of US equities (source: Research Affiliates). During the last EM crisis (1997-1998), EM stocks were valued at a premium to US stocks. It is likely that a lot of bad news is priced into the asset class. According to valuation work by Rob Arnott of Research Affiliates, emerging market stocks are the most attractive asset class on a risk/reward basis over the next 10 years.
Demographics: Consumers entering the middle class will continue to rise. Morgan Stanley’s analysis highlights that the compound growth of new middleclass households will be 10% or more annually for India, China and Indonesia through 2030. This means more than 350 million households will become middle class over the next 12 years! Think about the demand for stuff (cosmetics, food and beverage, electronics, etc.) that will follow.
Volatility is to be expected: During the last emerging markets bull market (2002-2007), there were 5 corrections of 10% or more in emerging market stock prices. The average pullback was 17%. (Calamos Investments). Nothing we are seeing today is out of the ordinary. Investing in emerging markets comes with risk. Emerging markets encompass many different countries each with unique political, market and legal considerations. Brazil is much different than India. If we do see a full-blown trade war between the US and China, more downside is likely.
While we remain optimistic on emerging market stocks, before making any investment changes, speak with your advisor.