If you were burned by emerging market stocks last year, you might want to give the relationship another chance in 2012. The stocks are doing pretty well so far this year, and analysts point to multiple reasons the gains should continue.
During the first four weeks of the year, Vanguard's MSCI Emerging Markets, the largest emerging market stock index ETF, was up nearly 11.6 per cent - more than double the 5 per cent return for the SPDR S&P 500.
The upswing indicates to investing experts that a drop of almost 20 per cent in emerging market stocks last year wasn't a bubble bursting.
"After burning investors last year, we expect the BRIC countries to be among the top-performing markets in 2012," said Ned Davis Research analyst Anthony Welch of the four dominant emerging markets: Brazil, Russia, India and China. "We think this is a good time to add to exposure to those markets."
The stocks and the funds that invest in them are still vulnerable to many of the same shocks that rumbled through the markets in 2011; but analysts say a combination of positive economic trends, comparatively strong growth, and down-to-earth prices make the recent upswing not just a recovery bounce, but an opportunity.
To support his optimistic outlook, Welch, in a January client report, pointed to a demonstrated ability of those countries to manage the delicate balance between controlling inflation and maintaining economic growth. He also pointed to signs of stabilization among global economies.
'Good Shot' At Outperforming US Stocks
Another draw for investors: stock prices are trading at a discount compared to historical levels even afterthe recent rally, said David Semple, Director of International Equity at Van Eck Global.
According to Semple's estimates, the group is selling at less than 10 times forward earnings, compared to their historical range of 12 to 13 times earnings.
"That's not as cheap as the post-crisis periods of late 2008 and early 2009, but it's quite attractive," he said.
But he also cautioned that a worsening of the European debt crisis or other developments could throw at least a temporary wrench into the picture.
"Emerging market stocks have a good shot at outperforming US stocks this year, but that could easily change if the Europe situation turns into an ugly mess. And other potential problems -- such as an unanticipated slowdown in developed market growth, too much credit restriction in China, and even weather-related issues that could impact food prices -- are still there," he said.
Investors are also keeping an eye on slower economic growth in the more mature emerging market countries, especially China. This year, the World Bank expects gross domestic product growth in that country to come in at 8.4 per cent compared to 9.2 per cent last year and 10.3 per cent in 2010.
Still, GDP growth in emerging market countries is likely to continue to outpace expansion in the United States and Europe by a healthy margin, according to the most recent projections from the Conference Board, a New York-based business and economics research group funded by major corporations.
The Conference Board said it expects growth in developed economies to slow down from 1.6 per cent in 2011 to 1.3 per cent in 2012 while emerging market growth will decelerate from 6.4 per cent in 2011 to 5.1 per cent this year.
Emerging Market Economies
The positive impact that comparatively robust emerging market economies could have on those countries' stocks is the main reason Weyman Gong, chief investment strategist at Signature Financial Management in Norfolk, Va., allocates as much as 20 per cent of his clients' stock portfolios to exchange-traded funds (ETFs) and mutual funds that focus on those regions.
For broad exposure to emerging markets he uses two ETFs, Vanguard MSCI Emerging Markets and iShares MSCI Emerging Markets. As of Friday, they were up 11.57 per cent and 11.65 per cent, respectively, so far this year.
"In the US and Europe, consumers are so highly leveraged that they have to use money to pay off debt rather than spend," said Gong, whose firm manages some $2 billion in assets for high-net-worth individuals and families. "Emerging market households aren't nearly as consumed by debt, so they have more money to feed the growth engine."
Even with the group's notoriously sharp downturns and snap-backs, Gong believes that retirees should have an allocation toward emerging market stocks in the low teens.
"Treasury bonds may seem safe, but at current yields they provide no protection from inflation," he said. "Putting money under the mattress won't protect you 20 or 30 years down the road."
Mark Martiak, vice president at Premiere Financial Advisors in New York, New York, typically invests between 10 per cent and 20 per cent of his clients' equity portfolios in emerging market securities. Because they don't perform in sync with other asset classes such as US stocks and bonds, he sees them as a good way to diversify.
"Emerging markets will remain the fuel for world growth, and secular themes such as population growth and an emerging middle class are truly powerful drivers," he said. "But I always warn my clients that the short-term headline risk with these securities is very real."