Emerging Market Equities Still Leader of the Pack

by: , Managing Director and Senior Portfolio Manager, MainStay Investments

The global equity market generated outstanding results in 2017. Among the leaders of the pack were emerging market equities, as the MSCI EM Index (net) gained 37.28% during the year. After such strong results, investors may feel the opportunity for further gains has passed them by. But we see the potential for further gains in 2018, as the underpinnings from last year’s rally remain largely intact.

Compelling Valuations

Even with last year’s sharp ascent, valuations on companies based in the developing world tend to compare favorably to those of more advanced economies, especially that of the U.S. This is partially due to the relatively weaker returns for emerging market equities over the last three-, five-, and 10-year periods.

1 Year 3 Years 5 Years 10 Years
S&P 500 Index 21.83% 11.41% 15.79% 8.50%
MSCI Emerging Markets Index (net) 37.28% 9.10% 4.35% 1.68%

Source: All data as of 12/31/17. Past performance is no guarantee of future results. An investment cannot be made directly into an index. Index definitions found at the end of this blog post.

Superior Growth Trends

Another potential driver for emerging market equity returns is the backdrop for global growth. While the economic expansion in developed economies improved in 2017, it still lagged their emerging market counterparts. And, this trend could continue, as developing economies experience these tailwinds:

  • These countries tend to be heavy exporters and are, therefore, leveraged to the strong upswing in the global economy.
  • Domestic consumption is generally growing in developing economies, due to a rising middle class.
  • Many developing countries are broadening their economies, so they won’t be as closely tied to fluctuating energy and material prices.
  • Certain developing countries have younger and growing populations, improving infrastructure and communications, more expansive access to educational opportunities, and a gradually deepening rule of law.

Against this backdrop, it’s not surprising that the International Monetary Fund (IMF) projects gross domestic product (GDP) growth of 4.9% in 2018 for emerging market economies, more than double that of the 2.3% expansion for developed economies.

Not All Emerging Markets Are Created Equal

While developing economies, as a whole, are on solid footing, it’s important to differentiate the opportunities on a country-by-country basis. In our view, preference should be given to countries that are early in the expansion phase of the economic cycle, as well as those with younger populations. We also prefer countries that have reasonably stable government institutions and are not overly reliant on foreign capital inflows. Specific countries that come to mind include Indonesia and Brazil. At the other end of the spectrum is China, where leverage has grown dramatically in recent years, as the government attempts to sustain high levels of growth.

Being Mindful of the Risks

To be sure, investing in emerging market equities is not without risks. In addition to those associated with all equities (i.e., loss of principal), there are additional risks associated with investing in emerging markets. These include great return dispersions, currency considerations, the potential for the breakdown of the rule of law, and the expropriation of assets. Against this backdrop, we advocate a diversified approach when investing in emerging market equities, such as can be done through mutual funds and ETFs.

Conclusion

We believe emerging market equities have the potential to generate solid results in 2018, albeit with less robust gains than we saw last year. We feel allocating a share of a well-diversified portfolio to emerging market equities can enhance one’s return potential, while still maintaining a reasonable level of risk. The size of an investor’s allocation to emerging market equities should be based on his or her unique objectives and risk tolerance.

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.

About Risk

All investments are subject to market risk, including possible loss of principal. Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline. A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
International Monetary Fund – an international organization that promotes the stabilization of the world’s currencies and maintains a monetary pool from which member nations can draw in order to correct a deficit in their balance of payments: a specialized agency of the United Nations.

The MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure equity market performance in global emerging markets.

The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302.

1767726

Jonathan Swaney

Managing Director and Senior Portfolio Manager, MainStay Investments

Jon is a Managing Director and Senior Portfolio Manager in the Strategic Asset Allocation & Solutions Group.  His current focus is on management of the MainStay and third party asset allocation strategies

Full Bio

Leave a Reply

Your e-mail address will not be published.