The Case for Emerging Markets

With U.S. equity valuations very rich by historical standards, many – including Jeremy Grantham, Rob Arnott and Vanguard – are predicting emerging markets to excel. I’ll examine the case and give my thoughts on how to invest in emerging markets.

Grantham’s GMO is predicting emerging-market value stocks to outpace inflation by 5.6% annually over the next seven years. This is in stark contrast to U.S. large cap lagging inflation by 6.6% annually and small cap lagging by an even greater 7.8% annually.

And there is no safety in bonds, also lagging inflation dramatically.

Jeremy Grantham isn’t alone. Morningstar’s Christine Benz summarized experts’ long-run forecasts, also using real inflation-adjusted returns.

Research Affiliates and Vanguard agree with Grantham on emerging markets and predict real returns between 4.5% and 9% annually, though they also predict international-developed markets will perform nearly as well as emerging markets. While not as pessimistic as GMO, the other experts predict muted US stock returns between a small loss and a 5.7% annual gain.

Based on those expert forecasts, there is a strong case for at least overweighting emerging markets and emerging-markets value in particular.