Emerging markets: looking beyond the past

Written by: Global Thought Leadership | March 24, 2017
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Source: Bloomberg, as of 2/28/17. Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • Investors concerned about the recent run-up in U.S. stocks might consider emerging markets (EM), where valuations are lower.
  • Consider the price/earnings (P/E) ratios for each region. The MSCI EM P/E was 15.7 at the end of February—compared with 21.7 for the S&P 500. That 6 point gap is well above the 20-year average of 4.7.1
  • While a P/E of 15.7 (which above the 20 year average of 14.8) might not seem overly attractive given the sometimes turbulent history of the sector, current factors and future prospects support a sympathetic view.
  • If so, investors waiting for valuations to retreat (to the very low levels of the late ‘90s, early ‘00s and financial crisis of ’08-’09) before stepping in could be disappointed. 
  • Why is this unlikely? Because fundamentals in these countries are much more robust—and the economic outlook is improving—as noted by EM equity specialist manager Martin Currie.
  • Another factor to keep in mind: the MSCI EM Index itself has changed significantly in recent years, making P/E comparisons to the past much less relevant.
  • For example, the index weighting to higher debt/lower return on equity (ROE) sectors like materials and energy (which tend to have lower P/Es) is much lower today, while lower debt/ higher ROE sectors like technology have greater prominence.
  • In other words, the index P/E may be higher today, but it represents a different mix of companies that may deserve a higher valuation.
  • The key for investors, of course, is being able to access the best-run businesses positioned to benefit from the strong secular trends that define EM, such as a growing middle class, the rise of e-commerce and the expansion of financial services—which requires the kind of selectivity available through active equity managers.

1 Source for all data is Bloomberg and Legg Mason, as of 2/28/17.

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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

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