- Emerging markets offer remarkable growth at a heavy discount to the broader market.
- But severe technical weakness in a notable emerging-markets ETF suggests stock-picking is best.
- Claire Noel and Chris Meredith of O’Shaughnessy Asset Management share their firm’s best ideas.
Stock-pickers torn between tantalizing growth and attractive valuations should look to equities in emerging markets, according to O’Shaughnessy Asset Management (OSAM).
Emerging markets offer stocks with higher revenue and earnings growth rates, as well as healthier profit margins, compared to counterparts in the US and other developed markets — all while trading at a 50% discount based on price-to-earnings ratios, OSAM’s quantitative research team found.
“It is difficult to find high expected returns with equity prices at all-time peaks,” OSAM Portfolio Manager Claire Noel wrote in a recent note. “However, on a relative basis, emerging markets look like a bargain with a P/E multiple of 17x versus 34x and 40x in developed international and the US, respectively.”
Investing in emerging markets is getting easier as barriers like low
and high costs recede, Noel wrote, adding that the group is still overlooked. Active investors can exploit inefficiencies while diversifying their portfolios, given the low correlation between the MSCI Emerging Markets ETF (EEM) and value, growth, large caps, small caps, and other segments.
Chris Meredith, the co-CIO of OSAM, a quantitative asset manager with $6.5 billion in assets under management, told Insider in a recent interview that emerging market stocks are “incredibly cheap” in the near term because US investors have a “home-country bias.”
“US markets are at high valuations historically, but valuation has been a terrible timing mechanism for markets,” Meredith said. “… Having a balanced, diversified portfolio is the best advice we can give.”
But there’s more to emerging-market investing than riding the EEM. The EM-focused exchange-traded fund broke out in December 2020 after over a decade of underperformance but has since rolled over, noted Stephen Suttmeier, a technical research strategist at Bank of America.
The Wall Street saying “the bigger the base, the higher in space” would suggest that a 13-year period of consolidation for the EEM would spark a feverish rally after the ETF broke the downtrend line from its 2007 peak late last year. But the EEM tapped out at $58.29 in February and has struggled since, Suttmeier wrote, adding that the ETF is testing a crucial “must-hold” level of support for EM bulls at $50-$51.
Another bearish sign for the EEM is that the monthly chart of its performance relative to the broad-based S&P 500 dropped to an 11-year low with no signs that it will bottom anytime soon, Suttmeier wrote.
But opportunities remain in emerging markets for active managers, regardless of the technical weakness in charts of the ETF tracking the group.
Four EM sectors and subsectors offer especially attractive total returns, according to OSAM: Energy, Materials, Transportation, and Taiwanese semiconductor companies. The firm said the latter has an “ample runway for growth” because the 5G upgrade cycle and global chip shortage benefit quality semiconductor suppliers.
By contrast, OSAM recommends avoiding emerging market Health Care stocks, whose valuations are relatively similar to their developed market and US peers.
Chinese stocks, which some firms distinguish as different from their EM counterparts, are “chronically underweighted in leading indexes and ETFs,” according to OSAM. The group has come under heavy antitrust fire recently, but OSAM strategists said investors should consider adding exposure to China-specific indexes and the nation’s Consumer Discretionary and Industrials sectors.