Emerging markets have had a rough year… bad enough that the scene is being set for a comeback.
At the end of October, the MSCI Emerging Markets Index was down 15.1 percent in 2018. China was down 24.8 percent, and Turkey was the biggest decliner, with a 45 percent drop.
In a challenging year, where the MSCI World index is down 0.9 percent, there aren’t a lot of bright spots. After a lousy October, the S&P 500 Index is up 4 percent for the year. The Euro Stoxx 50 Index hasn’t fallen as much as emerging markets, but is down 10.3 percent.
And this is just the latest bout of emerging market underperformance. The world’s developing markets have been suffering for a while. And now they’re very cheap on a valuation basis.
Cheap based on earnings
Emerging markets currently trade at a price-to-earnings (P/E) ratio of 11.7 times, compared with 17.1 times for developed markets. That’s a big discount. But emerging markets are almost always cheaper than developed markets.
More interesting is that the 10-year average P/E for emerging markets stands at 17.4 times – so they’re trading at around a 32 percent discount to what their average valuation has been over the last 10 years.
Admittedly, that includes a big P/E spike in 2008-2009, as earnings fell (and, thus, the P/E rose, despite falling share prices) in the global economic crisis. A more helpful comparison is to look at the five-year average P/E of emerging markets, which stands at 14 times earnings. So right now, emerging markets are trading at a 16.4 percent discount to the five-year average.
Cheap also on a P/B basis
The price-to-book (P/B) ratio refers to how much stocks are trading for relative to their book value per share – which is how much each share is worth based on a company’s total stockholders’ equity.
Right now, emerging markets trade at a P/B ratio of 1.5 times, compared with 2.3 times for developed markets. That’s a 36 percent discount, and one of the widest discounts of the past 10 years. The average discount for the past 10 years has been 16.7 percent… and for the past five years, 31.2 percent.
And based on history, that could be good news for emerging markets in coming months.
Since 2001, when the P/B discount of emerging markets has been this wide, emerging market stocks have gone on to outperform developed markets by 100 percentage points over the following five years.
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Of course, every market stage is different. Part of the cause of the high P/B valuation of developed markets (and thus, the higher valuation premium relative to emerging markets) may be the high P/B valuations of the tech sector. Technology companies generally have lower book values (and thus higher P/B ratios) compared to other sectors – and technology shares have outperformed in U.S. markets in recent years, resulting in higher representation in overall market valuation.
So based on history, emerging markets may be at a turning point. The easiest way to invest is through the iShares MSCI Emerging Markets Index ETF (NYSE; ticker: EEM). It holds 980 stocks from a range of markets, with the biggest representation from China, Taiwan, South Korea and South Africa. Its three largest holdings are Chinese multinational conglomerate Tencent Holdings (Hong Kong; ticker: 700)… Taiwan semiconductor company Taiwan Semiconductor Manufacturing (Taiwan; ticker: 2330)… and South Korean electronics giant Samsung Electronics (South Korea; ticker: 5930).
Publisher, Stansberry Churchouse Research