EM Stocks: Room to Move

Written by: | October 20, 2017

Source: Bloomberg, 9/30/17. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. 

The Bottom Line

  • U.S. stocks have soared in recent year; not surprisingly, so have valuations, whether measured on a P/E (price to earnings) or P/B (price to book) basis.
  • Given a Goldilocks scenario of strong earnings, low unemployment and moderate growth, that expansion is hardly irrational.  The question, however, is how much farther they can go – and whether ex-US stocks may be better positioned for growth in the years ahead. 
  • Developed markets like Europe and Japan have their potential, given recent glimmers of better growth.  But for those ready to accept the risks, emerging markets (EM) arguably have even more potential for expansion – despite an impressive rally of their own in 2017 (up 28% through the end of September*). 
  • Consider valuations relative to the U.S. market, as shown above.  On a price-to-book value basis, the MSCI Emerging Market Index, at 1.7, is far below the 3.2 valuation for the broad-based MSCI US Index (as of 9/30/17).
  • Comparative valuations, of course, offer clues, not proofs, of the relative potential of different markets. But business conditions in many emerging markets countries are different than they used to be, on many levels, and merit a closer look.
  • EM countries now account for more than 75% of the world’s growth in output and consumption, almost double their share just two decades ago [IMF, April 2017], thanks in part to the rapid expansion of the Chinese and Indian economies.
  • What’s more, as global equity manager Martin Currie notes, corporate earnings have been solid in 2017, and massive demand for technology by a rising middle class is empowering local firms, expanding the traditional EM base beyond resources and manufacturing.
  • EM is a sector that is particularly ill-suited to a passive index-based investment approach, given the huge differences between EM countries, their business climates and economic cycles.  Active managers who can be selective about what they own, leveraging specialized experience to track firms with attractive long-term potential, may provide a better map of opportunity than passive strategies locked into the idiosyncrasies of their respective indexes

*Source: Bloomberg, total return for MSCI Emerging Markets Index, 1/1/17 through 9/30/17