While the S&P 500 Index and the Dow Jones Industrial Average continue to charge higher, emerging markets (EM) have slumped.
EM is down about 3% from February highs, judging by the moves in the iShares MSCI Emerging Markets EEM, +0.94% Vanguard FTSE Emerging Markets Index Fund VWO, +1.14% and the iShares Latin America 40 ILF, -0.03% exchange traded funds.
Is this a confirmation that EM skeptics like MarketWatch’s Howard Gold are right, after all? Or is this a chance to buy an asset class that will outperform U.S. stocks over the next few years. I’m going with option No. 2 for the following five reasons. I offer 17 ways to get exposure to emerging markets at the end of this column.
1. EM is a defensive play
This is completely counterintuitive. But history shows it’s true. During the three bull markets since the mid-1990s, EM significantly outperformed developed markets during the final years of the economic and market cycles, points out Jim Paulsen, chief investment strategist at The Leuthold Group.
EM stocks were the “consummate end of cycle investment,” he says, despite significant headwinds for them at the time: Their central banks were tightening monetary policy, they were nearing a recession, and the dollar was strengthening, which is normally bad for EM.
EM should get an extra boost as this cycle matures since many of their central banks are getting more accommodative, they have more political stability than ever, and the dollar should weaken, which normally helps this group. Plus EM is under-owned, another positive, says Paulsen. As EM outperforms, fund managers who are underweight will feel pressure to increase their exposure to keep up.
2. EM looks cheap
Emerging market stocks are cheaper than U.S. stocks, one reason fund manager Charles Shriver has been increasing EM exposure in the T. Rowe Price Global Allocation Fund RPGAX, +0.65% over the past several months. The fund, which beats its category by 2.1 percentage points annualized over the past five years, is about 50% overweight emerging markets compared to its neutral allocation.
The MSCI Emerging Markets Index has a forward price-to-earnings (P/E) ratio of 12, compared to 16.6 for the S&P 500. EM also looks cheap compared to its own history.
3. But EM is growing a lot faster
Deutsche Bank economists expect EM gross domestic product (GDP) growth to come in at 4.6% in 2019 compared to 2.5% for the U.S. and 3.5% for the global economy. EM analysts at Franklin Templeton expect the return of EM earnings growth momentum in 2019, following last year’s slowdown.
Economic stimulus in China will be one of the main reasons. “You have some concerns in the market about slowing global growth, which certainly is a risk,” says Shriver, who co-chairs the asset allocation committee at T. Rowe Price. “But slowing global growth has been a catalyst for stimulus measures in China. While the impact may take time, we think it will be broadly supportive of EM in Asia. We see earnings growth in the high single digits for 2019, and decent revenue expansion.”
4. The Fed has turned dovish
This is one of the main reasons USAA has an EM overweight, says Wasif Latif, the head of global multi-assets at the financial-services company. A dovish Fed means the dollar should weaken, which typically benefits EM stocks. One reason is that many EM countries sell commodities, and commodity prices tend to go up when the dollar weakens.
5. A resolution in the trade war will provide a catalyst
“I assume China and the U.S. will work out a deal because it is in both parties’ interests,” says Lewis Altfest of Altfest Personal Wealth Management, which has $1.25 billion under management. He doesn’t think President Donald Trump will get all the concessions he is looking for. But the deal will be enough to calm worries about trade, and spark investor interest in emerging markets.
How to play emerging markets
Shriver, at T. Rowe Price, suggests tilting toward consumer and financial stocks, and away from more cyclical energy and materials names. China consumer companies that are prominent in T. Rowe Price emerging market funds include Alibaba BABA, +2.77% Tencent TCEHY, +1.43% Baidu BIDU, +1.73% and the travel website Ctrip.com CTRP, +0.35% Altfest likes General Motors GM, +1.28% as a China consumer play because of its big presence there.
In banking, Shriver likes Sperbank SBRCY, -2.08% which trades below book value even though it is taking share in Russia and it pays a 6% dividend yield. T. Rowe Price also favors banks in India, including Axis Bank AXB, +1.04% Altfest likes HDFC Bank Limited HDB, -1.82% for exposure to the growing banking sector in India. And he likes PagSeguro Digital PAGS, +1.78% a play on the rollout of mobile banking and cutting-edge financial services in Brazil.
I single out the names above because they have U.S. listings. But the truth is, most EM stocks can be hard to buy in U.S. brokerage accounts — at least retail accounts. So it makes sense to consider mutual funds, which buy on the local stock exchanges. I always favor funds with good long-term records.
Like the T. Rowe Price Global Allocation Fund, the following funds beat their category over the long term, according to Morningstar. They are: T. Rowe Price New Asia fund PRASX, -0.59% (outperforms by 2 percentage points, annualized, over the past 10 years), the T. Rowe Price Latin America PRLAX, +0.56% (1.2 percentage points) and the Franklin International Growth Fund FNGZX, +0.90% (1.8 percentage points).
Altfest favors the Matthews Asia Growth Fund MPACX, +0.16% Matthews China Fund MCHFX, -1.22% and the Matthews China Dividend Fund MCDFX, -0.25% all of which have good long-term records.
For India, consider the Wasatch Funds Emerging India Fund WAINX, -1.56% It has relatively high fees, according to Morningstar, but it beats competing funds by an impressive 7.5 percentage points, annualized, over the past five years, the longest time frame available for comparison on Morningstar. If fund manager Ajay Krishnan is right, India is a play on a mega-trend. He thinks India is in a growth phase that will last as long as 30 years, in part, because of business-friendly reforms that will continue to support growth.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested CTRP and GM in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.