Advanced economies are expected to grow 1.7% in 2016, while emerging economies will grow 3.5%. In 2017 and 2018, as commodity prices are expected to rebound from the 2016 lows, emerging markets will reach growth of 4.4% and 4.7%, respectively, while advanced economies will grow only 1.9% in both years.
From an economic perspective, India is the clear leader, followed by China and Indonesia. But before rushing into these emerging markets, we have to analyze the risks.
As emerging markets are vast, any kind of trouble in Japan, Europe or the U.S. immediately impacts them as investors consider emerging markets risky due to their volatility, and thus pull their funds out at the first sign of trouble. But, the underlying fundamentals, demographics and economic growth makes emerging markets a much better certainty than developed economies sustained only by quantitative easing and low interest rates.
From a PE perspective, the iShares MSCI Emerging Markets ETF has an average PE ratio of 11.62 (this is a skewed metric because it does not take negative EPS into account, but it’s still good for comparison with the S&P 500), and the S&P 500 ETF has an average PE ratio of 19.75 (this also doesn’t include negative PE ratios).
On the one hand, we have better economic growth prospects, better demographics, and cheaper stocks with emerging markets, while on the other we have aging populations, slow economic growth, and expensive stocks in developed markets.
From a long-term perspective, the picture is very clear: emerging markets will be the drivers of global growth and returns to your portfolio. But from a shorter-term perspective, emerging markets have more short term risks, from currency swings to volatility from panic selling. As such, the best thing to do is to rebalance your portfolio weights.
When emerging markets are hot, lower your exposure, and when other investors are running away—as they did in January 2016,—increase your ownership. To execute such a strategy, you have to be willing to accept potential short term declines, and be ready to buy more when they occur. In the long term, you’ll be more exposed to the inevitable growth emerging markets offer.