After a 25%-plus move higher this year, many investors are starting to get nervous about the odds of additional upside in emerging-market equities. The market, however, is sending far different signals.
The upward surge is far from over. In fact, it may still be in its infancy. There are seven important factors telling me to hold on to my bullish expectations for the sector.
Why I Think Emerging Markets Are Only Going Up
1. Economic Growth
Developed markets are experiencing a growth slowdown while emerging markets are in a long-term expansion phase.
While developed markets are forecasted to grow by just 2% in 2017, emerging markets are projected to hit 4.5% growth this year. The growth is predicted to climb nearly 5% in 2018.
#-ad_banner-#The BRIC nations (Brazil, Russia, India, and China) create 22% of the global GDP, a figure that continues to climb. An expected 80% of total world GDP growth will come from emerging markets over the next five years, according to the International Monetary Fund (IMF).
India and China’s portion of world GDP has grown by six times since 1970. The G7 nations’ share of world trade has declined from 50% to 30% during the same period.
Consumption is a primary driver of economies. Believe it or not, the IMF reports that close to 85% of consumption growth is thanks to emerging markets.
This economic growth, when compared to the traditional developed markets, creates a solid case for long-term investment in emerging markets.
2. Stock Market Valuations
Emerging market equity valuations are very persuasive. The long-term average price-to-earnings (P/E) ratio for emerging markets is around 25. Currently, the cyclically-adjusted P/E ratio is just under 13.
When compared to the S&P 500 index’s average P/E of just over 23, emerging markets trade at roughly a 25% discount to developed markets. This makes emerging market equities a no-brainer for value investors.
3. Global Trade
While the Trump administration may throw a monkey wrench into the global trade picture, emerging markets are responsible for over 50% of developed markets’ trade.
As long as emerging markets policies remain the same, it’s possible that they will become even bigger winners as developed markets play less of a role in trade.
4. The Commodity Shift
In the early 2000s, energy and material stocks made up 30-40% of global emerging market capitalization. This large proportion of commodities created tremendous volatility in these markets.
Today, a shift has taken place. That weighting has dropped dramatically, with only 15% of emerging market capitalization dependent on materials and energy. The rise in consumerism turned the focus to financials, consumer staples, industrials, and IT.
Less volatility means a smoother equity curve, which attracts big money investors that help support the equity markets.
Approximately 80% of the world’s population resides in emerging markets. Overall, emerging-market citizens skew younger than developed nations. The younger demographic combined with rapidly increasing wealth leads to greater consumption and, with it, economic growth.
Economic growth is reflected in average annual projected rates of nearly 8% for India, 6% for China, and close to 4% in Colombia over the next three years. Comparing these numbers to the paltry 2% expected in the United States, and forecasted growth creates a compelling case for emerging market investments.
6. Central Bank Policy
Accommodative monetary policy from developed nations’ central banks has kept interest rates ultra-low. The low levels have lifted demand for higher yielding emerging-market stocks.
Following United States’ lead, several emerging market central banks are in the midst of a monetary easing (interest rate lowering) campaign to bolster economic growth.
It also helps that the stronger U.S. dollar increases the price of U.S. exports while decreasing the cost of foreign goods. This dynamic acts to lower U.S. earnings while improving earnings overseas.
7. Price Momentum
Investors should not forget price momentum when choosing investments. The iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) is higher by nearly 26% in 2017 so far. Its steady upside momentum incentivizes continued investment from behemoth trend-following funds, which I expect will lead to another series of all-time highs.
Risks To Consider: With the substantial opportunities in emerging markets comes considerable risk. Both internal and external political risk, combined with youthful economies, create much uncertainty for investors. Emerging market investing is only suitable for investors who understand the considerable risk factors.
Action To Take: Consider allocating a portion of your portfolio to the iShares MSCI Emerging Markets ETF or a similar fund. Buying price breakouts with a trend-following strategy has been solidly profitable this year.
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