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Should You Dig Into the Undervaluation of EM ETFs?

Sanghamitra Saha
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Emerging-market stocks have probably seen “their worst weekly losses since early February.” Overall, 2018 has so far been pretty upsetting for emerging market (EM) ETFs.The main cause for the EM pain in the first half was the dollar rally, which is why emerging markets witnessed the “worst start to a year since the 2013 taper tantrum.”

As talks of faster-than-expected Fed rate hikes started doing rounds, U.S. Treasury yields moved higher and the greenback gained strength and EM stocks fell flat. Then came the turmoil in Turkey and Argentina in August. The double whammy had a spiraling effect on EM currencies. Plus, there are trade tensions between the United States and China, and country-specific political problems.  Many emerging market assets are trading at record lows.

Buy the Dip in EM ETF Selloff?

Many are thinking that it is a buying point because of the undervaluation in emerging market equities compared with domestic stocks. Per an article published on Forbes, companies are trading 18 times forward earnings which is above the long-term price to earnings (P/E) ratio of 15 times, resulting in 20% overvaluation.

On the other hand, EM stocks are trading below their long-term average of around 16 times. EM equities are trading at nearly 11 times, 30% lower than their historical average of 16 times. EMs are distributing dividends at 3.35%, 82% higher than U.S. stocks. These numbers indicate that there is the potential for outperformance in emerging market stocks.

Per JP Morgan, EM equities could soar about 15% over the next six months as developing economies are reducing their performance gap with U.S. peers. Not only J.P. Morgan, UBS Group AG and Morgan Stanley also find value in emerging markets.

Some investors are even of the view “that the end of the Fed's interest hike cycle may be coming into sight.”After all, the Fed’s future rate hikes are priced in at the current level (read: Has EM Selloff Bottomed Out? ETFs to Tap).

Any Wall of Worry?

Though long-term fundamentals are positive due to undervaluation, EM stocks could see further selloff if U.S. Treasury yields keep trending higher. The Indian rupee is at a record low. China’s trade relation with the United States are getting sourer, Brazil and Argentina are not out of any upheaval. Also, any flare-up in trade tensions and hawkishness in other central banks from developed markets may hurt the bloc.

ETFs in Focus

Still, below we highlight a few ETFs that have low P/E ratios and have lost relatively less than EEM (down 15.4% year to date).

iShares Emerging Markets Dividend ETF DVYE – P/E 9.48x

WisdomTree Emerging Markets Equity Income Fund DEM– P/E 9.73x

KraneShares MSCI One Belt One Road ETF OBOR – P/E 10.86x

PIMCO RAFI Dynamic Multi-Factor Emerging Market Equity ETF (MFEM) – P/E 12.13x

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WISTR-EM HI (DEM): ETF Research Reports
ISHARS-EM DIV (DVYE): ETF Research Reports
PIM-R DYN MFEME (MFEM): ETF Research Reports
KRANS-M OBORI (OBOR): ETF Research Reports
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