EM’s Golden Hour
It’s one of the best times to invest in emerging markets.
A New Day
Long associated with historical volatility, emerging markets (EM) equities have been considered too risky for many investors. But some significant economic and market shifts have created one of the best environments to invest in EM in a decade.
EM Clouds Have Lifted
Key challenges to EM investing have lifted recently: a dominating U.S. bull market and economic growth cycle as well as a strong U.S. dollar. It’s no secret that the U.S. has been the bright spot for investments in the past decade, making it difficult for EM to compete for asset flows. But with economic data signaling slower U.S. growth and accelerating growth in EM, investors shouldn’t ignore the strong opportunities that exist beyond U.S. equities.
The currency outlook for investing in EM has also brightened. The U.S. Federal Reserve confirmed in June that they will remain accommodative, pointing to a stable U.S. dollar whose strength won’t mask growth and price appreciation in EM currencies.
Benchmark in a Different Light
Despite EM’s history as a volatile asset class, this isn’t your grandparents’ EM. Today’s MSCI EM Index is more stable, with volatility that more closely resembles developed markets than it did even a decade ago. The index was once driven by older behemoths in cyclical sectors such as energy and materials, but now its leaders include more domestically focused firms in the technology and consumer discretionary sectors (think: Taiwan Semiconductor and Alibaba).1
The volatility spread between the MSCI EM Index and the MSCI USA Index has narrowed significantly in recent years.
If lower EM volatility stats are compelling, EM valuations are even more so. EM remains attractively priced versus U.S. markets,2 especially considering many economies in emerging markets are leaving the bottom of an economic cycle.
What Approach Captures Today’s EM Opportunity?
Because EM countries are connected to the broader global economy, it’s important to note that slowing global growth, headline risk, and changes in monetary policy, among other factors, have the potential to increase volatility in emerging markets.
One approach to mitigating potential volatility is focusing on EM stocks that are less driven by global influences and more focused on domestic consumption. Putting an emphasis on countries where political uncertainty has decreased (like Brazil, Indonesia, Peru) or economic and political reform has increased productivity (China, India), uncovers attractive opportunities within home borders.
Moreover, a balanced portfolio with a diversified set of strong companies in various life stages, styles and geographies, can help steer through sharp rotations or disruptions in the market while also capturing EM growth opportunities. Today’s environment creates a tailwind for EM as a whole, but a repeatable, disciplined investment process that balances company, sector and style exposures is all the more crucial when dealing with the diverse set of markets within EM.
The combination of accelerating growth in the asset class, a favorable currency outlook and attractive valuations compared to U.S. stocks reveals a golden hour for emerging markets equity investing. But don’t get blinded by the light; approach still matters. EM deserves more attention as an allocation and not just as tactical exposure, so be prepared for the long term.