Outlook for Emerging Markets

Emerging Market Sector and Country Exposure charts

Source: Factset, 6/30/18.

A bear market in emerging-market stocks started in September when they dropped 20% from their January peak due to the impacts of the stronger U.S. dollar, declines in Chinese stocks and concerns about higher tariffs. Emerging markets appear attractively valued, and the fundamentals look solid in most of the larger countries. Although increased trade tensions, rising U.S. interest rates, higher oil prices and a stronger dollar remain risks, we believe emerging-market equity investments represent an opportunity for long-term investors.

China is the largest emerging market – Chinese stocks are the largest holdings – about 30% – of the benchmark MSCI emerging-market equity index, as the chart shows. Seven of the 10 largest companies are Chinese. In 2018, as China’s economic growth slowed to near 6% and tariff threats escalated, China’s stock market dropped 26%, pulling down broad-based emerging-market equity investments as well. Despite ongoing concerns about higher tariffs, we think trade disputes are likely to be resolved by negotiations. In addition, China’s government continues to have many tools to maintain growth and address high levels of domestic debt.

Risks from tariffs, a stronger dollar and rising U.S. interest rates – Historically, emerging markets have faltered when U.S. interest rates rose and the dollar strengthened, and headlines have emphasized the sharp drops in some emerging currencies such as Turkey and Argentina. But their combined impact is less than 2% of the benchmark, and technology, not commodities, has become the largest sector. Higher tariffs and trade disruptions could continue to dampen the short-term outlook, since many emerging economies are closely tied to global trade. While risks remain and further fears could prompt additional short-term price drops, we think many of these risks are already reflected in attractive valuations and positive fundamental conditions in the largest countries.

Action for investors

We recommend investors diversify portfolios with international equity investments, including emerging markets. Although challenges remain and emerging markets can be volatile, we think using the pullback presents an opportunity to add broad-based emerging-market investments if appropriate.

Important Information:

Equity investing involves risks. The value of your shares will fluctuate, and you may lose principal. Special risks are inherent to international and emerging-market investing, including those related to currency fluctuations and foreign political and economic events.

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