In our Delegate Advisors Asset Class Indicators for the first quarter of 2019, we raised our outlook for emerging market equities from underweight to neutral-to-overweight, reflecting what we believe to be an attractive long-term opportunity. The shift in outlook is based primarily on the current valuation of the asset class. As shown in the below chart, the cyclically-adjusted price-to-earnings ratio (“CAPE”) for emerging market equities was 12.1 as of 12/31/2018, well below its 10-year average of 14.7.
Additionally, while emerging market equities naturally have lower valuations relative to developed markets due primarily to the inherent risks of the asset class, the spread between the valuation of emerging markets and developed markets is currently wider than average, implying that, relative to global developed markets, emerging markets represent a better value.
Given this backdrop, we expect emerging market equities to outperform developed markets over the long term as their valuation converges to the long-term average and as the spread between valuations for developed and emerging markets tightens.
One caveat, however. While emerging market equities may currently appear undervalued, the asset class is historically very volatile, meaning that large, sudden moves (both positive and negative) are common and expected. Thus, investors who are unwilling to “ride out” this volatility should consider an alternative.
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