Emerging market stocks have been “dead money” for almost a decade.
Emerging markets are countries that are on their way to becoming “developed” like the United States or Germany. Brazil, Russia, India, and China—the so-called “BRIC” countries—are the biggest emerging markets.
More than 80% of the world’s population lives in these countries. Since 2008, these economies have accounted for 80% of the growth in global economic trade and output.
You would think this would have made them great investments. But emerging markets have actually been a horrible investment lately…
Take a look at the chart below.
It shows how the iShares MSCI Emerging Markets ETF (EEM), which tracks more than 800 emerging market stocks, performed from 2007 through 2015. You can see that it went nowhere.
You would have actually lost about 0.15% of your money if you held EEM over this period, and that includes dividends.
• Because of this, many investors have given up on emerging market stocks…
But that could soon change.
Last year, EEM gained 8.6%. It was its first annual gain since 2012.
This year, it’s already up 10%. That’s more than double the S&P 500’s 4% gain.
More importantly, it looks like EEM just “broke out.” Below, you can see it recently bucked a downtrend it’d been stuck in since early September.
• This is good news for emerging market stocks…
As we often point out, stocks usually keep rising after a breakout like this.
And that’s exactly what EEM’s done. It’s rallied about 6% since piercing its downtrend.
It’s now at the highest level since July 2015.
Of course, you probably want to know if emerging market stocks will keep rising.
Over the next couple days, we’re going to try to answer that question.
We’ll dive deep into the fundamentals of emerging market stocks. We’ll look at the good and the bad. By the end, you’ll know if emerging market stocks are right for you.
Let’s start with what we like about them…
• Emerging market stocks are much cheaper than U.S. stocks…
You can see this in the table below.
This table compares EEM with the SPDR S&P 500 ETF (SPY), which tracks companies in the S&P 500.
EEM’s price-to-book (P/B) ratio is 49% lower than SPY’s P/B ratio. Its forward price-to-earnings (forward P/E) ratio is 36% lower. It’s also 34% cheaper according to the price-to-sales (P/S) ratio.
| Forward Price/Earnings
Looking at this table, emerging market stocks might seem like a no-brainer. But let's be honest…
• You should have to pay more for U.S. stocks…
After all, the United States is still the most powerful and stable economy on the planet. And investors pay premiums for safety.
Emerging markets, on the other hand, are far less stable.
China, the world’s biggest emerging market, is a communist country. Brazil, another huge emerging market, has had five currency crises in the last eight decades.
In short, emerging market stocks come with heavy baggage. Because of these risks, many investors want to “be paid extra” for owning emerging markets. They want better returns or higher yields.
With this in mind, you have to ask yourself: Are emerging market stocks worth the risk?
• Emerging market economies are growing rapidly…
According to the International Monetary Fund (IMF), emerging markets grew 4.1% last year. For perspective, the U.S. economy grew 1.6%.
This year, the IMF expects emerging markets to grow 4.5%. It expects the U.S. economy to grow 2.3%.
For 2018, the IMF projects that emerging markets will grow 4.8%, compared to 2% for the U.S. economy.
In other words, emerging market stocks are cheap and offer more growth potential. This is what every investor looks for.
But this has been true about emerging markets for years. And yet, they’ve basically done nothing while U.S. stocks have soared to record highs.
What would make this time any different?
• Commodity prices have taken off…
Palladium is up 14% this year. Silver’s up 12%. Copper has gained 9%.
Keep in mind, commodities have been falling for the better part of the last six years. The Bloomberg Commodity Index (BCOM), which tracks 22 commodities, declined 58% between April 2011 and last January. Since then, it’s up 21%.
This has given emerging market stocks a huge boost.
You see, countries like Brazil, Russia, Venezuela, and Saudi Arabia export far more commodities than they import.
When commodities rise, these exporters make more money. Their economies grow faster. Their stock markets climb higher.
Higher commodity prices could be the catalyst that emerging market stocks have been waiting for. But that doesn’t mean you should blindly invest in them.
Tomorrow, we’ll tell you what we don’t like about emerging market stocks.
At the end of that issue, you’ll know whether emerging market stocks deserve a spot in your portfolio.
Chart of the Day: How “Broad” Is Your Exposure?
China is driving the rally in emerging market stocks.
Earlier we told you that China is the biggest emerging market economy. It’s also by far the largest holding in EEM. It makes up 26% of the index. It has more impact on the fund than India, Brazil, Russia, and Mexico combined.
The chart below shows the performance of the iShares China Large-Cap ETF (FXI), which tracks large Chinese stocks, since last April. If it looks familiar, it’s because FXI has moved almost in lockstep with EEM over the same period.
This is important to understand.
You see, a lot of investors buy emerging market ETFs thinking they’re getting broad emerging market exposure. But many of these funds are heavily concentrated in big countries like China.
In short, if you own EEM, you’d better be bullish on China.
Delray Beach, Florida
February 16, 2017
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