What are considered emerging markets?
"Emerging markets," contrasted with "mature markets" like Western Europe, North America, Japan, New Zealand, and Australia, typically denote economies experiencing rapid growth, offering potentially higher returns compared to developed markets, albeit with accompanying risks.
According to the 2009 Morgan Stanley Emerging Markets Index, countries such as Brazil, Chile, China (mainland), Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Thailand, and Turkey are classified as emerging markets for statistical purposes.
Currently, Emerging Markets stocks are undervalued. The Price-To-Earnings Ratio of the S&P 500 index, based on profits from the past 12 months, stands at 22.4 times, whereas the Price-To-Earnings Ratio of the MSCI Emerging Markets index is 14.13 times. This index comprises the most liquid mid-cap companies from 25 Emerging Markets countries.
In 2023, the Emerging Markets stock market began to rebound. This was fueled by several factors: Firstly, as the interest rate hike cycle of European and American central banks gradually drew to a close, particularly in the fourth quarter of 2023, and these central banks paused interest rate hikes, the international liquidity environment eased, leading to renewed cross-border capital flows into Emerging Markets.
Secondly, the economic trajectories of developed and emerging economies started to diverge. While the GDP growth rate of developed economies notably slowed down, the overall growth rate of emerging economies remained relatively stable, attracting cross-border capital inflows.
Why prioritize emerging markets?
Emerging markets navigate global interest rate volatility
When the Federal Reserve tightens monetary policy by raising interest rates, investors typically shift funds from higher-risk emerging markets to lower-risk developed markets offering higher yields. This can trigger capital outflows from emerging markets, leading to stock price declines. Conversely, expectations of interest rate cuts can prompt capital inflows into emerging markets, bolstering the stock market.
As of February 23, 2024, net inflows into emerging markets totaled $33.86 billion, outperforming developed markets by 1%.
Consecutive interest rate hikes have resulted in a significant decline in valuation
In fact, the MSCI EM Index declined by about 26% since early 2021. In contrast, the S&P 500 Index of leading businesses listed in the US gained almost 30% over the same period.
As interest rates rise, capital flows back to the US, causing currency depreciation and higher borrowing costs in emerging markets. This, coupled with heightened investor risk expectations, diminishes demand for emerging markets assets, leading to a sharp drop in asset valuations.
Gabriel Shahin, President of Falcon Wealth Planning, an investment advisory firm in Los Angeles, remarked, "emerging markets stock valuations are now heavily discounted, making them one of the most prudent stock investment strategies at present."
World economic growth expectations
The International Monetary Fund (IMF) recently revised its World Economic Outlook report, increasing the global economic growth forecast for 2024 by 0.2 percentage points to 3.1% compared to its October report last year.
This adjustment is primarily driven by optimism regarding the growth momentum in China, the US, and several other emerging markets and developing economies.
Aniket Ullal, Senior Vice President and Head of ETF Data and Analytics at CFRA Research, stated, "One of the key reasons to consider investing in Emerging Markets ETFs now is the rapid expansion of middle-class consumers in high-growth markets like China, India, Mexico, China Taiwan, South Korea, and Vietnam." He highlighted that emerging markets boast a population exceeding 4.30 billion and contribute to approximately half of the global GDP.
Should invest in emerging markets now?
In 2024, the potential for a significant interest rate cut by the Federal Reserve has emerged as a crucial factor in global stock markets. The Federal Reserve has indicated that its cycle of rate hikes may be nearing its conclusion. This suggests that lower interest rates could lessen capital inflows, dampening demand for the US dollar and potentially weakening it.
According to Jason Xavier, head of EMEA ETF Capital Markets at Franklin Templeton, the Indian stock market is poised for a strong performance in 2023, largely attributed to its demographic dividend. Zewei also holds optimism for emerging markets, particularly those with strengths in the technology sector like China Taiwan and South Korea, suggesting they stand to gain from the global artificial intelligence trend.
Analysts at Guosheng Securities anticipate that, considering the global economic landscape, the Monetary Policies of major central banks, and the downward trajectory of the US dollar index, most emerging market stocks are likely to sustain an upward trajectory in 2024.
As of the third quarter of 2023, the iShares Core MSCI Emerging Markets ETF has become one of Bridgewater's largest holdings, making up 5.52% of its portfolio.
Risk in emerging markets investments
Investing in emerging markets stocks offers access to rapidly growing markets, but it also entails high volatility. Such investments encounter numerous challenges, including geopolitical instability, sensitivity to economic shocks, government policy changes, regulatory shifts, exchange rate fluctuations, and systemic risks.
These factors can heighten uncertainty surrounding investment returns, necessitating investors' full understanding before committing funds and their readiness to assume associated risks.
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