How to Take Advantage of the Emerging Markets Rally

One of the biggest opportunities for investors in 2018 is emerging market equities. While global markets (including the U.S.) experienced more pronounced synchronized growth in 2017, emerging markets outperformed dramatically this year – the MSCI Emerging Markets Index is up over 32% year-to-date (YTD). Based on long-term structural trends and strong earnings growth momentum, emerging markets outperformance is likely to continue throughout 2018.

In the U.S., tightening monetary policy and fiscal stimulus are likely to only have a negligible effect on emerging market equities. Instead, the future risks of emerging market equities should be classified as: U.S. dollar (greenback) appreciation, decline in commodity prices, China economic slowdown and geopolitical risks.

For 2018, the dollar is only likely to modestly appreciate (even with tax reform and 3 rate hikes on the horizon). Additionally, developing economies are becoming less dependent on dollar-denominated debt to fuel growth – meaning they will be less susceptible to greenback appreciation over time.

In terms of commodity prices, they are expected to rise in 2018 – a boon for emerging market equities. According to the World Bank, “oil prices are forecast to rise to $56 a barrel in 2018 from $53 this year as a result of steadily growing demand, agreed production cuts among oil exporters and stabilizing U.S. shale oil production, while the surge in metals prices is expected to level of next year.”

While growth momentum has started ease in China, this has been widely expected and is viewed as favorable to long-term growth. The slowdown is primarily coming from well-controlled deleveraging efforts (by the central government), anti-pollution controls and property curbs in the housing market. Long story short, we should expect that China’s economy will keep humming a long at a projected 6.3 percent rate of expansion and will not experience a hard landing in 2018.

As for geopolitical risks, unless a large exogenous shock (large-scale war, etc.) occurs, there will be only a modest short-term effect on price – meaning, expect a rebound to quickly occur. Looking back, 2017 was a year of many surprises (think: North Korea, Venezuela’s debt default, etc.) and yet emerging market equities deflected all of the geopolitical events.

As a U.S. based investor, the best way to gain exposure to emerging market equities is through ETFs. Currently, the top two emerging markets ETFs are: iShares MSCI Emerging Markets (NYSEARCA:EEM) and Vanguard FTSE Emerging Markets (NYSEARCA:VWO). The aforementioned ETFs are good for gaining broad exposure to emerging markets, however if you maintain directional views for specific markets, then other ETFs may fit the bill. For example, if you wanted to go long on Asian companies since they are projected to achieve a 50% increase in cash flow next year, then investing in the iShares MSCI Emerging Markets Asia ETF would be wise.

According to Merrill Lynch’s research, India, South Africa, China, Indonesia and Chile are expected to outperform in terms of EPS growth in 2018. In regards to industry sectors, earnings growth momentum is expected to be the strongest in technology, consumer discretionary, and healthcare stocks. Essentially, there are ETFs that provide direct coverage to both specific-countries and specific-sectors. Take the time to find out which ETFs cover your directional views and benefit from the existence of those ETFs.

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