3 Reasons to Stick with Emerging Markets

Emerging market stocks and bonds are having a rough year, but Russ argues against abandoning the asset class.

For the first time since late 2016, emerging markets (EM) are under-performing their developed market counterparts. While few asset classes—outside of oil—are having a stellar year, EM is having a particularly bad time. An index of developed equity markets is roughly flat year-to-date; EM stocks are down approximately 2%. Emerging market bonds are having an even worse year, down more than 5%.

What’s going on? Is it time to lighten up on the asset class? The answer to the latter question is no.

A number of catalysts are to blame. Emerging markets are struggling with a sharp and abrupt reversal in the dollar, concerns about global growth and idiosyncratic issues surrounding particular markets such as Turkey and Brazil. That said, there are three good reasons to stick with the asset class.

1. The return of relative value.

Like every other asset class, EM stocks and bonds have been cheaper. However, recent weakness has restored relative value, particularly for stocks. Based on price-to-book (P/B), the MSCI Emerging Index is trading at a 30% discount to MSCI World Index of developed markets (see accompanying chart). This represents the largest discount since December 2016 and compares favorably with the 10-year average of 14%.

2. Despite the typical first quarter slowdown, the global economy is in solid shape.

As I discussed back in late January, global economic growth is key for EM and I referenced industrial metals as a good real-time proxy for global growth. While softer in recent days, the JOC-ERCRI Metals Index has risen 20% during the past year and is still up 4% year-to-date. Other indicators of global growth, such as the global purchasing managers index (PMI), also confirm the ongoing expansion.