Emerging Markets: Still an Investment Opportunity?

As the U.S. market matures, many investors are looking to emerging markets for growth opportunities. Is that the right move?

neon signage in Asian city

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.

total annualized returns for key global indexes

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.”

Mike Woelflein is a business and investment writer based in Yarmouth, Maine. Image by iStock

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Global Investment Strategy is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A.

This article has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Individuals need to make their own decisions based on their specific investment objectives, financial circumstances, and tolerance for risk. Please contact your financial, tax, and legal advisors regarding your specific situation and for information on planning for retirement.

All investing involves risk including the possible loss of principal. Diversification strategies do not guarantee investment returns or eliminate risk of loss. 

Each asset class has its own risk and return characteristics which should be evaluated carefully before making any investment decision. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Investing in stocks involves risk and their returns and risk levels can vary depending on prevailing market and economic conditions. Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market. Foreign investing involves greater risks than those associated with investing domestically including political, economic, currency and the risks associated with different accounting standards. These risks are heightened in emerging markets.

Index Definitions
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.  The index consists of approximately 23 emerging market countries.

MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of 23 developed markets including the United States.

S&P 500 Index is a market capitalization-weighted index generally considered representative of the US stock market.

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