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Emerging markets: Cheap and getting cheaper

Emerging market stocks continue to take a beating in 2014. Indexes that track the so-called BRIC nations – Brazil, Russia, India and China – are among the world's worst performers in the first week of the year, following a big underperformance compared to developed markets in 2013. And few observers are willing to make a contrarian call in their defence.

Mohamed El-Erian, chief executive and co-chief investment officer at Pacific Investment Management Co. (or PIMCO), noted in the Financial Times that emerging market stocks look cheap, based on earnings. Yet, he advises against making any broad bet on a rebound: The factors that weighed on assets in 2013 will diminish this year, but not reverse.

Last year, emerging market stocks were held back by lower government stimulus and muted economic growth, which hurt corporate revenues; political instability in places like Turkey, Ukraine and Thailand, which reintroduced investors to a key risk of emerging markets; and the fact that emerging market companies didn't participate in share buybacks to the extent that U.S. companies did.

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Some factors are still in play: Foreign investors have fled emerging markets as the U.S. Federal Reserve winds down its bond-buying program; emerging market political and corporate leaders have over-estimated their resilience to outside shocks; and central banks have had to weigh tumbling currencies against declining economic growth.

Add it up, and Mr. El-Erian recommends investors should "differentiate by favouring companies commanding premium profitability and benefiting from healthy long-run consumer growth dynamics, residing in countries with strong balance sheets and a high degree of policy flexibility, and benefiting from a rising dedicated investor base."

Unfortunately, he doesn't provide any examples. Besides, buying individual emerging market stocks is beyond the scope of most retail investors, most of whom rely on mutual funds or exchange-traded funds for exposure.

One of the most popular ETFs, the iShares MSCI Emerging Markets ETF, has certainly been lagging developed markets. Since the start of 2013, it has underperformed the S&P 500 by a whopping 40 percentage points, after factoring in dividends.

For sure, momentum is working against emerging markets right now. But if you're concerned about U.S. valuations, they do offer a rare chance to scoop up stocks that are deeply out-of-favour and trade at just 12-times earnings (versus more than 17-times earnings in the case of the S&P 500).

This isn't to ignore what Mr. El-Erian is saying, but merely to suggest that now is not a bad time to invest in anticipation of better days ahead.

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About the Author
Investing Reporter

David Berman has been writing about business and investing since 1995. He has written for a number of magazines, including Canadian Business and MoneySense. He worked at the Financial Post as an investing writer and daily columnist before moving to the Globe and Mail in 2008. More

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