Emerging market stocks are off to a strong start in 2023, even as investor concerns persist. Emerging markets have underperformed over the past two years due to a rising dollar, interest rate hikes by central banks around the world and the continued impact of a pandemic of disrupted growth. The iShares MSCI Emerging Markets ETF (EEM) has fallen more than 22% in 2022 and more than 5% in the previous year. This year, however, that picture seems to have changed. EEM has advanced more than 8% this year, compared to the S&P 500’s 1.5% gain. Cheaper valuations have made emerging market stocks attractive to investors as a weaker dollar, easing inflation and China’s reopening are expected to benefit these assets. “One of the main draws for emerging markets has been the compelling valuation,” said Quincy Krosby of LPL Financial. “They were neglected again. They were, except Brazil was doing well again, India was doing well, they were basically being neglected by portfolio managers.” Still, investors differ from here on the outlook for emerging markets. Outlook Carlos Asilis, co-founder and chief investment officer of Glovista Investments, is bullish on emerging market stocks and advises investors to take an overweight stance. If emerging market stocks were to make up a 10% benchmark allocation in a global equity index, Asilis said investors should have about a 12% weighting. For investors with a higher risk tolerance, that allocation could go as high as 20%, he said. “I would say 12%, 11% is almost neutral, right? It makes sense to be at least 12%. And then maybe between 12% and I’d say 16% makes sense,” Asilis said. He added that most investors can considered a reasonable level of exposure. Others took a more measured stance. BCA Research’s Arthur Budaghyan said he did not expect the current rally in emerging markets to be sustainable and urged investors to wait on the sidelines for a better opportunity later this year. He expects the outperformance emerging markets could stall or partially reverse in the next few months. But for investors looking to get in later this year, it could turn out to be lucky. “I think sometime in the middle of this year we’ll get a bigger buying opportunity or transshipment in the second half,” Budaghyan said. He expects the reopening of China’s economy to accelerate more significantly in the second half, which will support emerging market economies. Furthermore, slowing growth in these economies, stemming from tighter monetary policy, could reverse later this year. Budaghyan recently initiated an upgrade watch on emerging markets, but remains underweight them within a global equity portfolio. He expects investors to be better off keeping their cash in money markets or global bonds over the next few months. LPL Financial’s Krosby, meanwhile, said the recovery in emerging markets could be short-lived and said any increased level of liquidity could push valuations to less compelling levels. “Any indication that the Fed market is wrong, any indication that the Fed may actually move to 50 basis points versus the probability of 25 basis points … that would be a bid for the U.S. dollar,” Krosby said. Not all emerging markets are created equal Although emerging markets generally perform better, some countries are expected to perform better than others. Many market participants expect Chinese stocks to beat their peers this year – despite some lingering concerns about travel. “Many of our peers were massively underweight China and they underperformed dramatically last year and earlier this month, so I think there’s a lot of buying in Chinese stocks ahead,” Glovista’s Asilis said. The iShares MSCI China ETF (MCHI) is up more than 12% this year, after falling 24% in 2022 and 22% in 2021. Other markets Asilis sees as attractive are Southeast Asia, Taiwan, South Africa and also Brazil. Meanwhile, BCA’s Budaghyan said he will be overweight in Mexico. While the country has exposure to the US, which Budaghyan has a negative outlook on, it has exposure to the auto sector. The iShares MSCI Mexico ETF (EWW) is up more than 13% in 2023. Budaghyan added that Mexico has leverage over the U.S. region, which still shows strong demand — that’s because previously a supply shortage made it difficult for people to buy cars. The strategist also favors exposure to South Korea and Chile. The iShares MSCI South Korea ETF ( EWY ) and the iShares MSCI Chile ETF ( ECH ) rose more than 10% and nearly 1%, respectively. One sector that Budaghyan would avoid is Chinese tech companies such as Alibaba, Baidu and Tencent. The strategist is concerned about the long-term outlook for these firms, given the government’s increased involvement in business.
