Will the revival in emerging market stocks that began last year continue this year, or after? Many investors are mulling that question after the brief but sharp decline in emerging market equities following the election of Donald Trump. Concerned about the impact of protective trade policies and a rally in the U.S. dollar, both of which are seen as negatives for emerging markets, investors unloaded emerging market stocks in the last two months of the year as the U.S. stock market staged a post-election rally. The selloff erased more than half the previous 10 months of gains and gave a good number of global money managers pause.

Soon after the election, according to a Bank of America Merrill Lynch investor survey, allocations toward emerging market equities had suffered their biggest month-on-month drop in over five years.

Yet emerging market investors also have cause to celebrate. After posting three years of negative returns, emerging markets ended 2016 up roughly 11.2% in dollar terms as fears abated about a “hard landing” in China, as commodity prices improved and as the dollar slowed its appreciation against emerging market currencies. The beginning of 2017 has also been encouraging, with broad emerging market indexes pulling ahead of U.S. indexes.

Beneath headline noise and market uncertainty lie ample reason for cautious optimism, says Leon Eidelman, who co-manages the JPMorgan Emerging Markets Equity Fund with Austin Forey and Amit Mehta. “This is the sort of environment where emerging markets tend to outperform developed markets,” he says.

He cites a number of reasons for that outlook. Commodity prices are improving, as is domestic demand by consumers in emerging market countries. For the first time in quite a while many companies are seeing upward instead of downward earnings revisions. Earnings growth among companies should outpace GDP growth, and from a historic perspective stock valuations are still reasonable.

In its 2017 investment outlook, J.P. Morgan Asset Management noted that while emerging market economic growth almost always exceeds that of developed markets, the gap narrowed from 3.5% just after the financial crisis to 1.4% in 2015 as developed markets plodded forward and emerging markets took a breather. Now, after years of painful adjustments to a new world of lower commodity prices and a services-led economy in China, the firm’s analysts expect that the worst is likely over for emerging market growth drought.

With lower expectations for developed market growth, but strengthening expectations for growth in emerging markets, the difference between the two is widening. This is a favorable sign for emerging markets.
Nonetheless, the report cautions, roadblocks to a potential recovery in these markets, including a stronger than expected dollar and very restrictive trade and immigration policies, could slow or reverse the trend.

Eidelman “won’t go down the political rabbit hole” trying to predict whether rhetoric about restrictive trade policy will turn into reality—or what impact that would have on the emerging markets. But he does think that the market may be reacting too strongly to such talk while overlooking broader, long-term story.

“People are looking at sound bites rather than what’s actually happening,” he says. “A feared trade war with China has morphed into more of a two-sided conversation. It’s also a stretch to say that politics in the U.S. is going to outweigh the strong drivers of growing domestic demand and [a] rising middle class in emerging markets.”

He also doesn’t spend much time worrying about volatility, a well-known fixture of the emerging market stock scene. “We’re buying businesses that we want to own over the next three, five or seven years, so we are in it for the long term,” he says. “We view pullbacks in emerging market equities as an opportunity to add to exposure, particularly if the pullbacks are driven by dollar strength.”

J.P. Morgan has a team of 40 analysts from around the world who uncover new ideas and help decide what stocks to buy and which positions to add to. Eidelman says his desk “is a stone’s throw away” from individuals representing six or seven nationalities, about half of whom speak Mandarin Chinese. He says this language capability helps them navigate the less-chartered waters of the Shanghai Stock Exchange, which has a more expansive roster of newer companies in the technology and retail sectors than the state-owned enterprises that dominate the more familiar Hong Kong exchange.

They seek out companies with low levels of debt, the ability to expand without borrowing, a clear path to growth and exceptional management. Fund holding Shoprite Holdings, a leading African supermarket chain that has enormous potential for expansion among a vastly underserved population, is one company that checks those boxes in spades. “Lagos, Nigeria, has over 20 million people and is one of the fastest-growing cities in the world, yet there are only about a half-dozen supermarkets, so the potential for expansion is enormous,” he says. Another holding in the region, South Africa-based Bidcorp, is the world’s second-largest food service and delivery company for restaurants, cafeterias, and other large buyers. It has a strong presence in Europe and China and a $7 billion market capitalization.

China’s Hangzhou Robam, another name that is unfamiliar to most people in the U.S., makes high-end kitchen appliances favored by the growing ranks of brand-conscious Chinese consumers. A key selling point for the company’s ranges, says Eidelman, is how well the built-in blowers pick up splatter from stir-fry cooking. The company, which has a $4.8 billion market cap, has a balance sheet as spotless as its stovetops and a high return on equity.

The public value of those stocks is much lower than average for the fund, which focuses mainly on large-cap blue-chip names such as top 10 holdings Tencent Holdings, Alibaba Group and Samsung Electronics. The portfolio of around 80 stocks draws most of its selections from the MSCI Emerging Markets Index, which has over 10 times as many companies, but differs from both that benchmark and its peers in a number of respects. About 20% of fund companies and frontier countries such as Vietnam and Saudi Arabia don’t appear in the benchmark. Growth sectors such as technology, financials and retail hold overweight positions, while value plays such as energy and materials have a smaller presence.

Among the countries where the fund is overweight is India, where it has nearly 19% of assets while the benchmark has only 8%. South Africa and Brazil carry above-benchmark weightings, while South Korea and China are underweight.

Several key themes run through the portfolio. These include emerging market e-commerce, where the pace of adoption is faster than in developed markets. Eidelman says most people in the U.S. don’t realize how evolved China’s internet retailers are, or how much their growth is outpacing that of their Western peers. He believes these retailers hold an advantage because unlike many Western e-commerce companies, these businesses aren’t burdened by the costs and complexities of running an existing network of physical stores, a big plus as consumers continue to migrate to the selection and convenience of online shopping.

The portfolio also holds a sizable chunk of innovative information technology software and service companies such as Epam Systems, which should benefit as more companies outsource their IT requirements. The company is based in Pennsylvania, but because it is a global player with a growing presence in emerging markets, the fund managers decided to include it as a rare U.S. holding.

Private sector banks are also dominant in the portfolio; they make up about half of the fund’s India allocation. These independent newcomers are gaining ground on the more established, government-owned public sector banks that have long dominated the landscape. Last year these stocks and other India holdings fell under pressure as the government demonetization program stirred doubt among investors about the possible impact on the banking system. But the market rebounded sharply in the first few months of 2017.

Eidelman believes efforts to weed out cash from India’s financial system will eventually have a positive effect on private banks by increasing deposits and triggering a surge in the use of digital money transfers. The migration to mobile banking should benefit holdings such as IndusInd Bank, one of the fastest-growing private banks in the country.

“India’s financial system serves 850 million people, and about two-thirds of lending is done by the public sector banks,” he says. “But private banks are gaining ground much more quickly in the area of mobile banking. They are also more profitable than the overstaffed and inefficient public sector banks.”