Despite recent struggles, some experts see brighter days ahead for emerging markets stocks.
Since losing approximately half their value during the recent recession, emerging markets stocks have generally recovered much of their value. But this asset class has clearly been the laggard of the ongoing recovery; emerging markets stocks have paced far behind equities of developed markets — most notably the U.S. — over the last several years.
Despite the disappointing performance since 2009, the long-term outlook for this asset class remains bright — at least in the eyes of several respected experts. Most long-term forecasts list emerging market stocks as the most promising asset class, with expectations of beating both stocks from the U.S. and other developed markets over an extended period of time.
Rick Ferri’s 30-Year Returns
In his 2015 version of this long-term forecast, Portfolio Solutions founder Rick Ferri projects a 9 percent annual return (including 2 percent inflation) for all emerging markets stocks. This is the highest projected return among the 18 asset classes he includes in his projection, beating out U.S. large-cap stocks (7 percent) and developed market stocks (7.4 percent).
Data Source: RickFerri.com
Research Affiliates 10-Year Returns
Research Affiliates, the firm responsible in part for the smart beta boom, updates long-term return projections on a quarterly basis. Similarly, this research firm expects emerging market stocks to deliver returns above those of developed economies. In this case, however, the expected outperformance relative to the U.S. and developed market stocks are much more significant; Research Affiliates anticipates that emerging markets equities will deliver an additional 650 basis points annually over large-cap U.S. equities.
Data Source: Research Affiliates
J.P. Morgan Long-Term Returns
J.P. Morgan publishes an annual report outlining its long-term return assumptions, along with all the data that goes into the calculations. The asset manager similarly expects emerging markets stocks to lead the way going forward, beating large-cap U.S. stocks by 225 basis points annually.
Data Source: J.P. Morgan Asset Management
So why exactly do the forecasts presented above expect emerging markets to lead the way in terms of returns over the long term? While each set of returns is backed by a proprietary, nuanced set of assumptions and data, there are some common themes. The simple explanation for the rosy outlook is that emerging markets stocks are cheap, especially compared to U.S. equities. Low valuations — especially when coupled with meaningful growth potential — generally indicate the potential for significant long-term price appreciation.
The following table shows several valuation metrics for the U.S. alongside the BRIC economies of Brazil, Russia, India, and China.
Data Source: Star Capital. CAPE = Cyclically Adjusted Price-to-Earnings Ratio.
Using the CAPE or Schiller P/E ratio, U.S. stocks are at one of their most expensive levels ever; only in 1929, 2000, and 2007 was this metric higher than its current level. But valuations in many emerging markets are much more reasonable, resulting in expectations that more upside potential remains in those economies.
According to an expected return calculation using CAPE ratios, several emerging economies are expected to deliver the strongest annual returns going forward:
Data Source: Guru Focus
The U.S. comes in nearly at the bottom of this list, with a paltry 0.1 percent expected annual return. Several other developed markets, such as Japan (0.7 percent) and Germany (0.5 percent), help to bring up the rear.
The presence of emerging markets atop a list of expected asset class returns is, of course, no guarantee that such results will actually occur. Many experts anticipated that emerging markets would have led the way higher during the recent recovery, and countless calls of a change in leadership have been made throughout the rally. So far, they’ve all been premature. But despite the recent struggles, these forecasts can serve as reminders of the potential this asset class has to enhance performance over the long term.
Featured image credit: Sam Valadi
About the Author: Michael Johnston
Michael Johnston is senior analyst for All Emerging Markets, and also serves as COO of parent company Poseidon Financial. His investment expertise has been featured in The Wall Street Journal, Barron’s, and USA Today, among other publications. He resides in Chicago.