Time to Invest in Emerging Markets?


Reed Walters

Emerging markets are a group of countries that are in the process of developing both their infrastructure and economic system.

Emerging countries include the big names that have dominated the space for years like Brazil, Russia, India and China (known as the BRIC), but also smaller developing countries in Emerging Asia, South America and Eastern Europe.

These countries tend to have higher potential growth, which makes them enticing to investors. The concern with investing in emerging markets is the risk as is timing.

For over a year now, emerging markets have sold off under the concern that a taper in the U.S. Fed’s quantitative easing program would send shock waves through much of the emerging markets financial systems.

Some currencies have been hit harder than others. In the last year, the Argentine peso and Ukrainian hryvnia have both dropped about 30 percent versus the dollar. However, at the opposite end of the spectrum, the Korean won has actually appreciated 7 percent.

As a result of the selloff ripple effect, emerging markets in general are trading at a significant discount to developed markets, both in the U.S. and overseas.

A common measure of valuation, the P/E ratio, where price is divided by projected next 12 month earnings, reflects the S&P 500 Index at 16.7x, the MSCI EAFE Index (a measure of developed non-U.S. countries) at 14.7x, and the MSCI Emerging Markets Index at 10.7x as of May 2014.

The prospective P/E ratio indicates emerging markets are currently trading at a 27 percent discount to the EAFE and a 36 percent discount to the S&P 500. Not bad if you are looking for decent relative valuations.

Additionally, many emerging markets countries should benefit from a stabilizing China. China has historically been “the” low-cost manufacturer/exporter. However, we have witnessed growing personal consumption in China.

The Chinese consumer market has grown to now 27 percent the size of the U.S. market, up from 8 percent in 2001. In just 2012 alone, China’s private consumption grew by $400 billion. Additionally, China’s wages have tripled in the last decade, which provides opportunity for other emerging countries to become low-cost alternatives to China.

The net result is many manufacturing-based countries that are net importers of commodities (as opposed to exporters during this period of low commodity prices) should be benefactors of China’s move towards becoming a developed country.

Keep in mind, there are still risks in the emerging markets and headwinds to fight through. Some concerns include less accommodative U.S. monetary policy, slower overall growth in the BRICs, weak commodity prices and political instability in select countries.

Remember, when looking at investing in emerging markets, it is prudent to consider it as part of your overall equity (stock) allocation, as a smaller percentage of your portfolio than your investment in developed countries, and as a higher risk growth component.

Walters is president and CEO of Sector Capital Management LLC.