U.S. markets were among the first to recover from the global recession of 2009. Today, as U.S. markets mature, many believe that emerging-market stocks still have room for growth. In fact, Wells Fargo Investment Institute forecasts that emerging-market equities will outperform both developed-market and U.S. stocks over the next 10 to 15 years.
"Earnings are on the rise, the economies are doing well, and economic growth remains strong," says Sean A. Lynch, CFA, Co-head of Global Equity Strategy at Wells Fargo Investment Institute. "However, we do see current risks within emerging markets that make us a little cautious in the short term; considerations include the impact of Federal Reserve interest rate hikes and higher interest rates as well as the continued uncertainty around the magnitude and targeted areas of tariffs. That being said, we do like emerging markets for the long term."
Diversification with emerging markets
In the wake of a banner year for emerging-market stocks — the MSCI Emerging Markets Index rose 34 percent in 2017 — Lynch hears investors who missed out asking if it's time to beef up their exposure, while those who benefited wonder if it's time to take profits. The answer, he believes, lies somewhere in between.
"Our view is that emerging markets should be a key part of all growth-oriented investment portfolios," Lynch says. "To us, it's no longer a question of should I have exposure or not."
Clients of The Private Bank have asset allocation targets based on their individual time horizon and risk tolerance. Advisors will often suggest increasing or decreasing exposure to certain asset classes.
"Right now, we're recommending that investors be right at their targeted level in emerging-market equities," Lynch says. "We're suggesting neither an overweight nor an underweight. But after this run-up, that in itself is a vote of confidence."
Emerging-market stocks have historically been a more volatile asset class — as evidenced by the annualized return over the last 10 years shown below, when they failed to keep pace with their peers. Lynch's advice, with that in mind: Revisit your asset allocation and equity exposure at least once a year, or even quarterly, to be sure your portfolio is diversified and aligned with your investing goals.
For illustrative purposes only. Index returns represent general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Index definitions provided at end of article.
The changing makeup of emerging markets
Historically, emerging-market indexes were full of commodity and basic materials companies, with state-owned banks driving the financials sector. That's changed dramatically over the last five to 10 years. Today, information technology stocks make up more than 25 percent of the MSCI Emerging Market Index.
To Lynch, that tech exposure provides drivers for growth and could provide drivers for valuation. Investors, he says, will pay more for an asset with steady, consistent growth than they will for an asset with a volatile earnings stream such as commodities and materials.
"We believe investing in emerging markets is investing in this global tech boom," Lynch says. "That means emerging-market equities today may be worth much more than they used to be."
Growth in a rising middle class
One of the long-running investment themes of emerging-market investing ties into demographics. Emerging markets tend to have younger, larger, and faster-growing populations, as well as a rising middle class thought to be primed to become potentially insatiable consumers of goods and services.
"We think that will drive those economies for the long haul," Lynch says. That's especially true in China, India, South Korea, and Taiwan, which have become the emerging-market index's largest country weightings. The growth is driven in part by thriving tech industries and a broader move toward innovation, along with value-added products and services.
"I think the technology and consumer areas are attractive areas," Lynch says. "We very much like the East Asia corridor. Bottom line, we think there's a lot of opportunity out there."