Despite emerging markets’ strong recent performance, I believe there are two major reasons why investors should still consider overweighting select countries relative to their weight in the MSCI ACWI benchmark.
1. Cheap Emerging Market Valuations:
First, and most importantly, emerging markets remain cheap compared both to their own history and to developed markets. Currently, the MSCI Emerging Market Index is trading for around 12x earnings. As the chart below indicates, this is a discount to the index’s long-term average multiple of 14.6x.
The current valuation of roughly 12x earnings is also a 45% discount to where the MSCI World Index (ACWI) is trading. And historically, when emerging market stocks have been at a 20% or more discount to developed market equities, they have significantly outperformed over the next year.
Market Realist – Emerging market valuations appear compelling
The graph above shows the PE ratio (price-to-earnings ratio) of the MSCI Emerging Market Index. Currently, the index is trading at 12.3x earnings. This is below the long-term average of 14.6x earnings.
Although many emerging markets (EEM) are slowing down along with the world (QWLD), most emerging economies are growing much faster than the developed world. China (FXI), for example, is still growing at above 7%. Given the low valuations in emerging markets, and moderate growth in some of them, you can consider entering select emerging economies. You find more on this in Part 4.
Among the BRIC countries (Brazil, Russia, India, and China), Russia (RSX) is struggling, as oil (USO) prices have slumped. India’s growth rate remains well below the 10% it briefly hit in 2010. However, it has recovered from its recent slowdown.
The next part of the series covers another reason why some emerging markets look attractive.