Emerging markets have been outperforming U.S. stocks, and investing experts think the rally could continue. Known for higher risk and potentially higher reward, emerging market stocks are an important part of a diversified portfolio, and now may be a good time to buy them.
Over the past year, the iShares MSCI Emerging Markets exchange-traded fund (ticker: EEM) is up about 22 percent while the Standard & Poor’s 500 index is up around 14 percent.
Over a longer period, however, emerging markets have lagged behind U.S. stocks. For the past five years, the MSCI index-tracking ETF has gained about 13 percent while the S&P 500 shot up a whopping 82 percent.
That gives Jeremy Bryan, a portfolio manager at Gradient Investments in Arden Hills, Minnesota, confidence that the emerging market rally hasn’t peaked yet.
“I think there is still room to run,” he says.
Bryan expects emerging market stocks, which are a better value than those in the U.S., to grow faster than domestic equities in coming years. The cheaper valuations are already coaxing investors, driving demand for emerging market stocks, Bryan says.
[See: 7 Ways to Tell if a Stock Is a Good Price.]
The case for investing. But the main reason emerging markets have been rallying is that global economic growth has picked up, says Don Riley, chief investment officer at Wiley Group in West Conshohocken, Pennsylvania.
Additionally, the relative underperformance of emerging markets in recent years removes some of the risk associated with investing in them when they are growing faster, he says.
Another key component of emerging market growth is China, where the economy is improving. “We’re starting to see re-acceleration of their growth,” Bryan says.
Also, a weakening in the U.S. dollar has accentuated gains in emerging market assets, says Katrina Lamb, head of investment strategy and research with MV Financial Group in Bethesda, Maryland.
If U.S. interest rates shift upward sharply, that would make emerging markets less attractive by strengthening the dollar and increasing emerging markets’ dollar-denominated debt burden, Lamb says. She thinks rate hikes will be gradual, however.
Riley doesn’t believe rising U.S. interest rates will be too much of a headwind, either. The dollar has been falling in recent months because some people think the Federal Reserve has gotten ahead of itself raising rates, he says. As emerging markets strengthen from internal growth, their own currencies will appreciate, he says.
Still, Riley cautions that even though emerging market economies look good right now, their stocks are inherently much riskier than equities in developed countries because they depend more on the global economy and external cash for financing.
Emerging market investments compensate for that risk with the potential for high growth, he says. They are also good diversifiers, offering sources of growth that don’t necessarily correlate with the performance of the S&P 500, he says.
China and India. Bryan thinks China and India are the best emerging markets to invest in now. “They’re going to be the growth engines for quite some time,” he says.
[Read: There’s an Investing Opportunity in India.]
In China, he likes Alibaba Group Holding ( BABA) because of its “phenomenal” management, e-commerce platform and cloud infrastructure. Alibaba is essentially an Amazon.com ( AMZN) for emerging markets. The stock looks expensive now, so short-term investors may want to see the share price drop 10 percent before buying, he says. For those with a five-year time horizon, buying now is probably fine, he adds.
China Mobile ( CHL) is another good option. Although it hasn’t done particularly well recently, Bryan expects the company’s long-term performance will improve amid a 5G network rollout and sales of the next generation of iPhones.
For a dedicated China fund, the iShares China Large-Cap ETF ( FXI) is “an interesting one to play purely China,” Bryan says. To invest in both China and India, he suggests the First Trust Chindia ETF ( FNI).
Investing broadly through exchange-traded funds. For average investors, Lamb recommends buying broader index-based exchange-traded funds, rather than investing directly in stocks.
Funds such as the iShares MSCI Emerging Markets ETF limit the need for analyzing emerging market companies, which can be difficult for a lay person to do, she says.
[See: 10 Great Ways to Buy Emerging Markets.]
Riley likes the Schwab Emerging Markets Equity ETF ( SCHE) because it offers “very broad-based exposure at a reasonable price.”
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Emerging Markets Are Still a Bargain originally appeared on usnews.com
