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Why We'll See an Emerging Markets Victory

Jody Chudley, Contributing Analyst, The Oxford Club

Jody Chudley

I'm ready to double down on a recent prediction I made.

On October 6, I predicted that emerging market stocks were primed for a long period of outperformance.

So far, that prediction looks pretty good...

But I think emerging markets are just getting started.

Since I wrote to you on October 6, emerging market stocks have outperformed the S&P 500 by 40%.

That is an increase of 13.73% in emerging markets versus the 9.78% increase in the S&P 500.

Chart - Emerging Markets Outshine the S&P 500
 

There are three reasons I believe that emerging markets still have a long way to run...

1. Emerging Market Stocks Are Still Dirt Cheap

Unlike the S&P 500, which is trading at very lofty valuations, emerging market stocks are clearly inexpensive.

Every valuation metric points to emerging markets being the best bargain in the global stock market.

Emerging markets are also the cheapest that they have been since 1999 – when there was an incredible buying opportunity.

In the decade following 1999, emerging markets beat the S&P 500 by almost 10% per year.

I can't guarantee that history will repeat, but with the way emerging market stocks are priced relative to the S&P 500, everything is set to make it happen.

2. A Decade of Underperformance Creates a Coiled Spring

The big technology stocks of today have driven the S&P 500 through an incredible 10-year run.

For months, I've been warning about how expensive some of those stocks have become.

I don't want to say tech stocks have created an S&P 500 "bubble," but I'm not surprised when I hear smart people throwing that word around.

While this Big Tech run has been happening, emerging markets have been getting no love from investors.

Chart - Emerging Markets Miss Out on the S&P 500's B Tech Run
 

While the S&P 500 has doubled over the past decade, emerging market stocks have gone nowhere.

Yet while stock prices have languished, emerging market companies have continued to grow earnings and value.

This sideways stock market movement is why the valuations on emerging markets are so compressed.

At some point, the cycle will turn back in favor of emerging markets just like it did in 1999.

When that happens, emerging market stocks could outperform for a long time.

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3. Emerging Market Currencies Are Also Undervalued

If you are at all worried about the soundness of the U.S. dollar, then you should know that there is no better way to profit from it falling than investing in emerging market stocks.

The relationship between the performance of emerging market stocks and the value of the U.S. dollar is one of the tightest macro relationships that exists in investing.

This, of course, is a big reason emerging markets have underperformed over the past 10 years while the U.S. dollar has strengthened.

The hard data shows that in years when the U.S. dollar declines, emerging market stocks are the best-performing asset class. Even better than gold!

Chart - The Dollar's Impact on Asset Classes
 

One study that covered the 45 years from 1974 to 2019 showed that, on average, emerging market stocks went up 22.5% in years when the U.S. dollar declined.

I'd like some of that action...

The U.S. dollar has had an incredible decadelong run against emerging market currencies.

Chart - The U.S. Dollar Has Finally Started to Fall
 

I believe that trend reversed this summer, and the recent weakness of the U.S. dollar against emerging market currencies is just the beginning.

Emerging Markets Are a Great Portfolio Diversifier

The case for emerging markets today is very sound.

And, of course, I love diversifying my portfolio.

If you don't have exposure to emerging market stocks, now is the absolute perfect time to get some.

The financial markets are cyclical. And with the U.S. dollar weakening and the end of the pandemic in sight, the cycle is finally moving back in favor of emerging market stocks.

From their current dirt-cheap valuations, these stocks have a long way to run.

Good investing,

Jody

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