Consider this: In the 12 months ending October 2015, emerging-markets stocks plunged 20% in U.S. dollar terms, as measured by MSCI’s EM index, while the S&P 500 was mostly flat. Ouch! 

But is the carnage over? Are EM stocks now cheap enough for clients to enter (or re-enter) this volatile, aggressive arena? 

“There’s always going to be volatility in the EM space,” says David Spika, global investment strategist at Dallas-based GuideStone Capital Management. “But lately it’s been in a vicious cycle.”

China Contagion 
This most recent cycle was sparked in August 2015, when Beijing’s central bank devalued the yuan to boost sagging exports. What resulted was the currency’s biggest one-day loss in decades: The yuan ended down nearly 2% against the dollar. Seen as a symptom of slow growth in the world’s second-largest economy, the bold move had a ripple effect. 

“It impacted the currencies of other EM nations, especially those in the Asia-Pacific region, which had to devalue their own currencies to stay competitive,” says Spika. “That in turn forced capital out of those markets, since investors don’t want to invest in places where the currency is being devalued, which put additional pressures on those currencies.”

At the same time, lower commodity prices had already been contributing to slow growth throughout the emerging markets, particularly in countries that depend on the exports of natural resources, such as Russia, Brazil and South Africa. “This cycle is really a function of four C’s—China, currencies, capital and commodities,” Spika observes.

Risk Aversion, Cheap Commodities 
There were other factors at work as well. “When the Fed starts to tighten, liquidity and the amount of capital available for investments declines,” says Spika. “Another contributor is lower risk appetites—EM investments are always considered riskier” than their counterparts in more developed economies.

Still, Spika acknowledges that these events haven’t affected all EM countries equally. “If you want to invest in EM at this point, I’d recommend commodity consumers, not commodity producers. Also particularly vulnerable at the moment would be countries that are largely dependent on Chinese trade for their growth, such as South Korea, Taiwan and Vietnam,” he says. “But you have to be careful, because there’s still some pain to be felt.”

Long-Term, Some Are Selectively Bullish
Yet others are more bullish, albeit selectively. John Frankola of Pittsburgh-based Vista Investment Management recently told clients, “Although the commodity-based economies of Russia and Brazil are forecasted to have slower growth over the next five years, China and India are expected to grow at rates substantially higher than the developed world.” Though Frankola does see short-term volatility ahead, he insists that EM stocks are “undervalued, with excellent long-term return potential.”

James Syme, senior portfolio manager at J.O. Hambro Capital Management’s Global Emerging Markets Opportunities Fund in London, might agree. “We continue to see attractive opportunities in the large Asian equity markets, particularly India and China, where we feel economic policy should be supportive of domestic demand growth, and Korea and Taiwan, where we see strong potential for the export part of the economy and equity market,” he says. Those countries, he adds, have plenty of “quality companies at cheap valuations.” He’s far more cautious on commodity exporters and “countries with large current account deficits, such as Brazil, Turkey and Indonesia.”

Frankola and Syme aren’t alone. “Is the worst over? No. But we’ve begun to establish long positions in some emerging markets and their currencies,” says Christopher McKee, CEO, owner and portfolio manager of the PRS Group, a global quantitative risk-assessment firm headquartered in Vancouver, British Columbia. Unlike the others, he lists Brazil, Argentina, Greece and Saudi Arabia as opportunities. “But our time horizon is quite long,” he cautions. “These markets have been beaten badly down and, given our risk metrics, it doesn’t appear that much more value destruction is likely.”

Near-Term Considerations
Of course, timing is everything. If U.S. markets wobble, investors may fear a bubble and rapidly shift capital to emerging markets as a high-growth alternative. “Near term, it is quite possible that the emerging markets could rebound somewhat,” says Stuart Quint, senior investment manager and international strategist at Berwyn, Pa.-headquartered Brinker Capital. He cites “tactical sector rotation into an area that has deeply underperformed,” but warns that EM stocks may not be as cheap as they appear, and sees a great deal of uncertainty ahead.

Though he’s not a fixed-income investor, Quint also notes that EM bonds—sovereign debt in particular, though corporate credits too, to a lesser extent—have fared better than their equity counterparts of late. EM debt, he says, “has been relatively unscathed and continued to have investor inflows.” But if that should change—if there were a significant decrease in institutional allocations to EM debt—that would signal more volatility in those economies, he warns. “One major key to watch is foreign holdings of EM bonds,” says Quint.

A downturn in U.S. equities could also presage a further EM slump. “The premium of economic growth in EM relative to developed markets, including the U.S., has come way down,” Quint argues. “EM is no longer the ‘growth stock’ sub-asset class it used to be. A protracted selloff in the U.S. could be negative for EM if it stemmed from economic recession.”

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