Case for Emerging Markets Stocks Brightens a Bit

Put simply, it’s been years since emerging markets stocks were worth investors’ trouble. Along the way, there have been numerous instances – too many to count – in which the asset class was supposed to rebound and deliver upside.

Fits and starts abound, emerging markets stocks are showing signs of life this year as the MSCI Emerging Markets Index is higher by 4,30%. That’s not setting the world ablaze, but it’s a step in the right direction and plenty of other emerging markets strategies are topping that benchmark as well as domestic equity gauges.

Fortunately for advisors and clients, the 2023 emerging markets “mini resurgence” is rooted in fundamentals, including China’s reopening, central bank support, the possibility of economic stimulus in China and more.

Considering Tailwinds for Emerging Markets Equities

There are good reasons to consider developing world stocks and the fact that there is more than one potential catalyst for the asset class further enhances the proposition.

“Emerging-markets stocks look poised to gain as multiple tailwinds emerge, including a weakening U.S. dollar, China’s quicker-than-expected reopening, and maturing economic conditions in several emerging-markets countries,” notes Morningstar analyst Lauren Solberg. “Although emerging-markets stocks don’t come without risk, China, Southeast Asia, and Latin America appear to offer potential rewards for investors.”

In another point in favor of stocks in developing economies is valuation. Yes, that’s something advisors have heard plenty about for several years now, but these days, the asset class is noticeably inexpensive relative to its own recent history and relative to domestic stocks.

“On average, emerging-markets stocks are cheaper now than they have been over the past 15 years,” adds Solberg. “That’s in terms of their price/earnings ratios, which are a commonly watched valuation metric comparing the stock’s price with its expected or historical earnings. The Morningstar Emerging Markets Index’s trailing 12-month price/earnings ratio is 11.1 as of April 2023—below its 15-year average level of 12.5.”

China Reopening, Maturity Matter

One of the most widely documented sparks for emerging markets stocks is China’s economic reopening following a three-year stretch of punitive coronavirus measures. Much of that is priced into Chinese stocks, but there’s talk Beijing could deploy monetary stimulus to prop up the country’s still ailing property market.

Recent buying of Hang Seng-listed stocks by foreigners suggest some global investors are comfortable making the stimulus bet or, at the very least, see opportunity in Chinese stocks.

Another factor to consider is that developing economies are significantly more mature today than they were a decade or two ago. That maturity is expressed in multiple forms, including better sovereign credit ratings and broader corporate revenue streams, among others.

Some companies in developing economies, such as Mexico, Taiwan and South Korea, depend on the U.S. for more of their sales than they do their home markets.

Emerging markets’ “debt/gross domestic product ratios, which have lowered substantially for several emerging-markets countries,” concludes Solberg. “(These) countries no longer have the fixed exchange rates, higher debt levels, and political uncertainty that they once had.”

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