What's behind the recent growth in emerging markets?

Aug. 21, 2017 | By Kristina Hooper

Kristina Hooper
Global Market Strategist, Invesco

Recent political risks in the US, stretched valuations and relatively low economic growth should all serve as a reminder to investors to be well-diversified. Many US investors are underweight in international stocks, particularly emerging market stocks, and may be missing out on potentially valuable diversification benefits.

Emerging market stocks have been quietly rising this year, outperforming developed market stocks. From the start of the year through Aug. 4, 2017, the MSCI EAFE Index had risen 15.65%, the S&P 500 Index had risen 10.63%, and the MSCI Emerging Markets Index returned 23.77%. The strong performance of emerging market stocks reflects an improvement in fundamentals. Among the "BRIC" countries (Brazil, Russia, India and China), China is experiencing higher-than-expected gross domestic product (GDP) growth, India is benefiting from significant reforms — particularly in the area of taxation - and both Brazil and Russia are experiencing economic improvement.

In general, growth prospects for emerging market economies are much higher than that of developed market economies. For example, in the International Monetary Fund (IMF) growth forecasts (as of July 2017), GDP growth for advanced economies is expected to rise 2% in 2017, while GDP growth for emerging economies is expected to rise 4.6%. For 2018, GDP growth is expected to be 1.9% for advanced economies and 4.8% for emerging economies. In addition, valuations are generally more attractive for emerging economies than for developed ones: The MSCI Emerging Markets Index currently has a forward price-to-earnings (P/E) ratio of 12.53 - that compares with 14.81 for the MSCI EAFE Index and 18.04 for the S&P 500 Index (as of July 31, 2017). Finally, I believe reforms in a number of emerging market countries - in addition to what will likely be a very gradual Federal Reserve rate hike cycle - have helped to create a supportive environment where there is the potential for significant upside.

Sources for index data: MSCI and Standard and Poor's

Important information

Forward price-to-earnings ratio is a variant of a company’s price-to-earnings ratio, and is calculated by dividing the company’s current share price by its expected earnings, usually for the next 12 months or next full fiscal year.

An investment cannot be made into an index.

The MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East.

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

Past performance is not indicative of future results.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

An investment in emerging market countries carries greater risks compared to more developed economies.

Diversification does not guarantee a profit or eliminate the risk of loss.

The opinions referenced above are those of Kristina Hooper as of Aug. 15, 2017. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.