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Many investors in emerging market (EM) stocks believe they made a bad allocation in
the past couple of months, and some investors have sold their stakes in disgust.
EM stocks, measured by the MSCI Emerging Markets Index, posted a strong gain of 37% in 2017, encouraging
investors to look at this asset class as we entered 2018.
After a strong January, EM stocks pulled back with the rest of the global stock market and are now down
about 15% from their late-January highs.
Despite this, WT Wealth Management believes it may be wrong to count EM stocks out of your portfolio.
Depending on a variety of personal factors, an allocation to EM is still appropriate for many investors. We
wouldn't be looking to sell or pare back current holdings. History has shown that the mid - or even late - stage
of the economic cycle just may be when emerging markets shine.
KEY POINTS
- EM stocks have shifted from taking the lead to coming up from behind in investors' opinions.
- Investors fear a regression to an economic environment that thwarted EM stocks before.
- The present economic environment may resemble those that had spurred EM stock out-performance.
MID-CYCLE ECONOMIC ENVIRONMENT
Past periods of EM stock struggle included the 1994 Mexican peso crisis, the 1997 Asian financial crisis, and
the 2013 Taper Tantrum. In each of these, the Federal Reserve took action to tighten monetary policy, going
so far as to taper back $70 million in bonds and mortgage-backed securities in the case of the Taper Tantrum,
which contributed to the MSCI Emerging Markets Index's 150.5% plunge a year later. Usually these types of
Fed action signify the exit from a recovery period or early economic cycle and entry into mid-cycle economic
recovery.
Yet these mid-cycle changes in monetary policy did not invert the U.S. Treasury yield curve, nor did a global
or U.S. recession follow them. However, they did boost the broad trade-weighted value of the dollar by about
20%, which weighed on EM stocks due to the dependence of EM stocks on dollar-based financing. Therefore,
EM stocks suffered during each of these mid-cycle periods, under performing their developed market peers,
as this chart shows.
EMERGING MARKET CRISES: INDEX CHANGE ONE YEAR AFTER INITIAL FED ACTION TO TIGHTEN MONETARY POLICY
The MSCI USA Index is designed to measure the performance of the large and midcap segments of
the US market across 631 stocks. The index covers approximately 85% of the market capitalization
in the US.
The MSCI EAFE Index, an equity index representing developed-market countries, includes stocks
from: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland,
Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden,
Switzerland, and the UK.
The MSCI Emerging Markets Index, comprising 23 emerging economies worldwide, includes stocks
from: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia,
Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand,
Turkey, and the United Arab Emirates.
LATE-CYCLE ENVIRONMENT
WT Wealth Management views the current economic environment as late-cycle, which has historically favored
EM stocks. The Fed took initial action to end quantitative easing and raise interest rates with its first rate
increase in December 2015. This move started the flattening of the yield curve, thus sparking the discussion
that this economic cycle is past its midpoint and into its later stages. Typically, the US dollar is relatively stable
at late cycle, which is good for EM stocks.
This stability in the dollar has, at least in part, led EM stocks to outperform during late-cycle environments in
the past as shown in the chart below.
EMERGING MARKETS ON TOP: INDEX CHANGE IN THE ONE-YEAR PERIOD PRECEDING INVERSION OF THE YIELD CURVE
SUMMARIZING LATE-CYCLE PERFORMANCE:
- EM stocks outperformed in two of the three periods covered in the chart above.
- EM stocks outperformed in spite of pressure put on them in some perpetually susceptible nations.
At WT Wealth Management, our experience, discipline and long-term investment focus drive us to evaluate
asset classes that are temporarily out of favor with investors. While EM stocks may have lost leverage during
the past quarter, our view that the markets are in a late-cycle environment gives us reason to see opportunity
in EMs after the recent sell-off.
Keep in mind that adding an asset class like emerging market stocks to your portfolio is based on your personal
risk tolerance, your investing time horizon, the strategy you are currently invested in, and a variety of other
personalized factors. Please contact your investment advisor professional if you have any questions or would
like to discuss the opportunities within EM stocks in greater detail.
Fuscaldo, Donna. "Charles Schwab: Don't Count Out Emerging Market Stocks." Investopedia, June 14, 2018.
View Source
Kleintop, Jeffrey. "Emerging Market Stocks: From Front-Runner to Dark Horse?" Charles Schwab, June 11, 2018.
View Source
Morgan Stanley Capital International. MSCI EAFE Index (USD). New York: MSCI Inc., 2018.
View Source
Morgan Stanley Capital International. MSCI Emerging Markets Index (USD). New York: MSCI Inc., 2018.
View Source
Rapoza, Kenneth. "Happy Anniversary to Market's Taper Tantrum." Forbes, May 23, 2014.
View Source
Silver, Caleb. "MSCI Emerging Markets Index." Investopedia, 2018.
View Source
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