Emerging Markets: A Re-Emergence?

By Peter Greenberger and Matt Feddersen

In recent years, emerging markets have faced a challenging investment environment leading many market participants to reduce or completely eliminate exposure to these equities. Slowing global growth, particularly in China, has been a powerful headwind as this leading importer of commodities-based emerging economies dropped from double-digit economic growth to the 6-7 percent range. Adding to the drag are additional setbacks including geopolitical risk, a strong U.S. dollar, and an abundance of unemployed youth.

Prior to the late-2014 downturn, when the MSCI Emerging Markets Index (MSCI EM) dropped 35 percent peak-to-trough, emerging markets were viewed as a source of great potential growth, with a rising middle class, a large youth cohort eager to be educated and employed, and the hope for improved infrastructure and manufacturing. These markets even fared well during the risk-off trading spree following the financial crisis of 2008, with part of this resilience attributed to these markets’ lack of involvement in the sub-prime loan business.

While challenges are country-specific within this asset class, a shared concern has been the impact of China’s slowing economy on the rest of the world. China’s transition from an infrastructure and trade-fueled economy to one driven by domestic consumption has been turbulent, to say the least, as investors anxiously watched to see if the government could manage a “soft landing.” In terms of 2015 GDP figures, China’s $10.9 trillion remains greater than the next ten largest MSCI EM constituent countries combined. Due to its significant position within the index and investor’s immense focus on GDP growth, China has rightly – or wrongly – become the target for investor sentiment concerning all emerging markets.

Many developed nations have aging populations that will likely consume less but require more services such as healthcare and assisted living. To the contrary, the European Central Bank estimated that over 80 percent of the world’s population currently resides in emerging market countries, and many are more heavily skewed toward younger populations. The transition of these economies from low-wage to a middle-income lifestyles is changing the way companies position their products and who they are selling those products to. Populations in countries like China and India are moving toward middle-income jobs where the consumer will eventually spend more disposable income on products and services. It’s not too far of a stretch to assume other emerging markets will follow suit and this demographic shift could be a meaningful source of global growth going forward.

Currently, emerging market equities are attractively valued but this hasn’t always been so. Just prior to and immediately following the global financial crisis, the MSCI EM’s price-to-earnings ratio (P/E) was trending above its long-term average as well as the S&P 500’s long-term average. Since mid-2013, this trend has reversed and the P/E for emerging markets has fallen below the S&P 500, implying that these equities are relatively inexpensive, not only when compared to the asset class’ historical average, but to U.S. equities as well.

While the case could be made that emerging-market equities are currently inexpensive because some of the largest companies in the index are beaten-down commodity producers and partially state-owned enterprises, the fact that this market remains relatively inexpensive remains compelling. China’s recent economic growth rate, while significantly lower than past years, appears to be stabilizing and is still over five times higher than U.S. growth. This suggests the economic transition is likely being managed successfully with a soft landing in the 6-7 percent growth range. Among other emerging markets, one could argue Brazil is in the very early stages of stabilization with the recent appointment of a more economically focused president. Political tensions between Russia and the Western world have also tempered.

As much as emerging markets were shunned over the last few years, things are looking brighter as major headwinds surrounding economic growth, commodity prices and political instability continue to ease.

Past performance may not be indicative of future results. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. There is no assurance that any estimate will be accurate. The performance analysis does not include transaction costs which would reduce an investor’s return. Alternative investment strategies involve greater risks and are only appropriate for the most sophisticated, knowledgeable and wealthiest of investors. © 2016 Raymond James Financial Services, Inc., member FINRA/SIPC. © 2016 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value. 16-BDMKT-2275 CW 10/16.Raymond James Financial Services, Inc., member FINRA/SIPC. © 2016 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value. 16-BDMKT-2275 CW 10/16.

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