Emerging Opportunity

June 16th Weekly Market Update

The emerging markets (EM) asset class has been especially disappointing for investors in the past few years as measured by the MSCI Emerging Markets Index. However, last week EM pulled ahead of the performance of the S&P 500 Index for 2014. Might this mark the beginning of the turn for EM relative performance? We think it may. A little history may help illustrate why.

EM investors in the 1990s were used to the huge up-and-down swings of the EM asset class as EM countries in Asia and Latin America were prone to financial crises — from the Mexican “peso crisis” in 1994, to the Asian “contagion” of 1997 – 1998, to the Argentine debt default of 2001. But from 2002 – 2007, the BRIC era (named for a 2001 paper on the emerging importance of the economies of Brazil, Russia, India, and China), EM stocks experienced a decade of spectacular performance resulting from a few key drivers.

Growth: China’s growth surged as it entered the World Trade Organization. China’s internal growth boom drove commodity prices higher (which were further fueled by a declining dollar), which benefited commodity producing EM countries. EM economies grew faster than developed countries.

Valuation: EM valuations rose even as developed market price-to earnings (PE) ratios fell as an environment of sluggish growth in developed economies prompted investors to seek rapidly growing EM companies. In addition to rapid growth, the valuations were supported by structural reforms undertaken in these countries that extended from the crises of the 1990s.

Interest Rates: EM countries benefitted from lower borrowing costs and an influx of foreign capital to fuel growth as global interest rates declined on lower inflation, European integration, and policymakers taking key rates to new lows.

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