This past spring we highlighted the argument for maintaining some exposure to emerging market (EM) equities (see "Emerging Markets: Caution, Not Abstinence," April, Market Perspectives). Since then EM stocks have outperformed their developed market counterparts. The asset class has benefited from stabilization in the Chinese economy, market-friendly election results in India and Indonesia and the growing perception that EM stocks are reasonably priced in a world with few bargains. The turn in fundamentals has also led to a turn in sentiment. EM equity flows have been positive for several months, although EMs are still under-owned for the most part.
Even after the recent rally, we still believe that emerging markets represent a long-term opportunity, and that investors still underweight should consider bringing their exposure back to at least a market weight.
That said, not all emerging markets are equal. EM Asia and parts of Latin America have rallied, but many markets in EMEA including Poland, Hungary and Russia continue to struggle. For these reasons, along with material differences in valuations, we believe that investors should continue to be selective.
On a relative basis, emerging markets in Asia, including China, appear particularly attractive. After several years of underperforming, the region remains relatively inexpensive, despite the recent gains. In addition, most of EM Asia should also benefit from relatively strong economic growth and less exposure to reversals in capital flows.