Why Emerging Market Equities Still Look Good

London - Emerging market (EM) stock indices have generally trailed the S&P 500 Index in the years after the financial crisis, although developing markets handily outpaced the U.S. in 2017.

The performance shift last year had some investors wondering if the pendulum is ready to swing back and favor EMs in coming years. After all, the alternating leadership of EMs or the U.S. tends to move in multiyear cycles.

Blog Image Emerging Markets Annual May 21

So far in 2018, EMs have lagged. However, we think giving up on an EM allocation to equities would be a mistake due to their diversification benefits, earnings growth, relative valuations and other factors.

That said, EM equities have faced several headwinds so far in 2018, including rising U.S. Treasury bond yields, a resurgent U.S. dollar, concerns over the potential for a U.S.-China trade war and increasing geopolitical risks.

Digging deeper, markets that are most sensitive to global liquidity tightening have had it the worst in 2018 -- Turkey, Indonesia and South Africa. In Turkey, rising oil prices and the announcement of early parliamentary and presidential elections, to be held in June, also increased uncertainty. Russia was negatively impacted by the announcement of new U.S. sanctions in response to "malign activity across the globe," according to Treasury Secretary Steven Mnuchin.1

However, EM valuations relative to the U.S. look attractive. The recent weakness has brought EM equities back under their 10-year average price-to-earnings (P/E) and price-to-book (P/B) ratios. Meanwhile, profitability is relatively healthy among EM corporates.