Five Reasons Why Emerging Markets Are Investable Today

Portfolio allocators rarely rely on one single factor when making investment decisions. Just because something is cheap, for example, doesn’t mean you should buy it. Investment results tend to be more favorable when multi-factor variables align themselves toward a specific investment outcome. This logic is particularly important in volatile and uncertain environments. Today, we believe there are five factors affecting emerging markets which point toward an attractive risk/reward for investors.

1. The Macro cycle

Since 1995, there have been five Federal Reserve interest rate-hiking cycles and they have all had several things in common. In the months leading up to the initial hike, market uncertainty tends to prevail and risk assets suffer as investors worry over inflationary pressures and potential central bank policy response. There’s speculation over the possible trajectory and cadence of future rate hikes and their potential effect on risk asset classes. In addition, the U.S. dollar tends to outperform both developed and emerging market currencies, and cyclical, value-oriented stocks tend to outperform growth-skewed companies.

In this cycle the Fed has so far hiked rates six times. We would argue that the cycle is advanced and the uncertainty surrounding the cadence and trajectory of future hikes is fading. U.S. rates may rise further but at a slower more predictable pace. At this point in the cycle, as Fed policy becomes less uncertain, risk assets tend to find their feet. At the same time, the U.S. dollar tends to stop appreciating against developed and emerging currencies and the growth-oriented stocks rebound against value stocks.

2. China

Experienced investors generally accept that emerging markets are often less predictable and more volatile than some other equity asset classes, such as European and North American stocks. Over the past 30 years, there have been many instances when emerging markets equities have fallen more than 15%. But it’s less common for emerging markets to fall over 30% in 18 months and even more infrequent for a major market, like China, to fall over 50% in that period. That’s exactly what has happened since May 2021.

China has been battered by several well-publicized headwinds, including the government’s regulatory targeting of Chinese monopolies (especially within the tech and e-commerce space), the default of several Chinese property developers and the massive negative economic impact of China’s zero-COVID policies. These headwinds have all led to a downgrade in earnings forecasts for Chinese companies.