Emerging markets are are outperforming developed markets

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December 18, 2018 1:54pm NYSE:EEM

global stocks

From Russ Koesterich, CFA:

It may seem like a poor environment for EM stocks, but they outperformed in the recent volatility. Russ explains why.

Global stocks are testing the fall lows, the VIX is over 25 and oil continues to collapse-not the ideal environment for emerging market (EM) stocks. Yet, while EM equities have traded lower-along with every other risky asset-they are outperforming developed markets.

In August, I suggested that EM stocks were beginning to look like that rarest of things in an aging bull market: a bargain. My timing, to be generous, was early. From the late July peak to the falling bottom emerging markets equities lost another 15%.

However, more recently EM stocks have been outperforming. Given the litany of concerns, from a trade war to tighter financial conditions, why are EMs outperforming and can it continue? Three factors to consider.

1. Still cheap, getting cheaper.

Emerging market stocks were inexpensive in July; they are cheaper today. Based on trailing earnings, the price-to-earnings (P/E) ratio has dropped from 13.1 to 12, the cheapest since late 2015. On a relative basis, the MSCI Emerging Market Index is still trading at a 30% discount to developed markets, close to the bottom of this cycle’s range.

2. A more range-bound dollar.

After rallying 10% from the February low to the August high, the rally has started to stall. While the Dollar Index (DXY) did make a nominal high in mid-November, more recently the index has been stuck around 96-97. This is important. In the post crisis-world, a rising dollar has been associated with weaker EM returns. Since 2010, monthly changes in the dollar have explained roughly 30% of the variation in emerging market equity returns. A flat dollar removes a key headwind.

3. Slower growth and inflation suggest rates may be peaking.

During the spring and summer, a stronger dollar coincided with rising interest rates. That has, at least temporarily, come to a halt. Investors are now more concerned about slower growth. This concern is beginning to show up in inflation expectations, which have recently fallen below 2%. Slower growth and decelerating inflation may allow for a quicker end to the Fed’s tightening cycle, another factor that would likely support EM assets.

Can EM rise?

Relative out-performance is one thing, but can EM assets actually start to rally? As others have commented, one way to frame 2018 is as a series of rolling bear markets. The trend was first evident in emerging markets but quickly spread to commodities, European equities, and most recently U.S. tech stocks.

In this light, EM’s biggest advantage may simply be the fact that it got the bear market out of the way early. With the asset class now trading at its lowest valuation since the 2015 bottom and some of the key headwinds abating, any shift in sentiment is likely to be accompanied by a big EM bounce. If or when that occurs, I see best opportunities in Asia.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

The iShares MSCI Emerging Markets ETF (EEM) was trading at $39.30 per share on Tuesday afternoon, up $0.42 (+1.08%). Year-to-date, EEM has declined -16.60%, versus a -3.31% rise in the benchmark S&P 500 index during the same period.

EEM currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #9 of 93 ETFs in the Emerging Markets Equities ETFs category.

This article is brought to you courtesy of BlackRock Blog.

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