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.”

Getting A Read On China
For Quint and others, positive signs would include sustainable growth in China. The problem for some, however, is getting a clear reading on China at all. “It’s a very opaque economy,” says Arjun Jayaraman, head of quantitative research at Los Angeles-based Causeway Capital Management and co-manager of its Emerging Markets Fund. “Beijing comes out with an official GDP number every quarter that nobody believes. So we don’t really understand where things are.” 

China, he asserts, is transitioning from a manufacturing-driven economy to a services-oriented one. While Chinese manufacturing may indeed be contracting, the services side of the economy appears to be expanding, “which is a good thing in the long run,” says Jayaraman, who is cautiously bullish. “The fears are coming from looking at the old indicators of where the Chinese economy is, rather than the newer indicators of what the economy is transforming into.”

In fact, Asia is his preferred EM region. He points out that China, India, South Korea and Taiwan have all lowered interest rates, which could further strengthen their economies. On the other hand, EM markets in Latin America, Eastern Europe and Russia remain a concern for Jayaraman, largely because of their dependence on commodity exports.

Investor Goals And Styles
His bullish view of emerging Asia is predicated on patience. He recommends waiting at least one year and preferably three for an EM rally. “Shorter time horizons would be tough in today’s markets,” he says. “But the longer-term investor you are, the better off you’re going to be if you invest in emerging markets.”

It's also a matter of how conservative or aggressive the investor is.  "For conservative clients, some degree of caution may be warranted,” says John De Clue, chief investment officer for The Private Client Reserve unit of U.S. Bank in Minneapolis. “For more aggressive investors, some participation may be appropriate.”

De Clue isn’t advocating an exit at current low levels. “It’s probably OK to maintain existing positions,” he says, “but I would not recommend adding at this point. I wouldn’t be trying to bargain-shop. I’d rather be patient and watch developments.”

If and when the time comes, he says, positions must be chosen carefully. “I strongly suggest that EM investors not use index funds, where you basically own a piece of every country,” he says. “The differences between the major EM countries are so stark that if you’re going to invest, it pays to use an active manager.”

Even so, he says no one should invest in EM debt at the moment. “A lot of these countries have been borrowing in U.S. dollars. That’s good, but the stronger the dollar gets the more debt service they have. At the same time, their revenues are in local currency. So you get this squeeze.” 

Picking and choosing among the different EM stocks certainly sounds sensible, but how is one to know which and when? “I’m hesitant to suggest that one should get into and then out of and then back into emerging markets,” says Bill Hoyt, head of research at San Francisco-based Lattice Strategies. “Despite the recent trauma, the growth dynamics and the long-term investment potential of the EM space are still there. So we do think some exposure is appropriate for many investors. It just should be handled more gingerly than other markets, to balance the risks.”

He singles out Indonesia. “Its economic development is now where China’s was in the mid- or late-90s,” he says. “It’s still working through market reforms and trying to stamp out government corruption, but there’s a significant opportunity there for pro-business development. It could end up being an economic powerhouse, given time.”

Specific country forecasts are not Hoyt’s style, however. “These countries can change their fortunes with something as simple as the election of a new government, and these things are often unpredictable,” he observes. “But you have to have the exposure ahead of time to capture the benefit. … You just don’t want to over-concentrate in any one country. You want to be exposed to many of them.”

Once Bitten …
Just as it may take time for EM investments to pay off, it will also take time before some investors regain the confidence to try. “Still a little bit too early, in my opinion,” says Bill McQuaker of London-based Henderson Global Investors, where he is co-head of Multi-Asset, co-asset allocation strategist of the International Opportunities Fund and co-manager of the All Asset Fund. “But one more meaningful setback—relative or absolute—and there could/should be a real buying opportunity.”

He’s looking for “a chance to invest” in 2016, since he says the basic long-term positives for the sector are potentially as good as ever and the EM bear market can’t last forever. “India remains the most attractive area,” he contends. “It has its own economic dynamic; it’s not tied to China in the way many of the [other] EM countries are; and it benefits from some of the prevailing trends in markets, such as lower commodity prices.”

Some investors are looking to further improvements in the U.S. economy as a leading indicator for emerging markets. “As the U.S. economy ignites and heats up, so too will the economies of emerging markets on a lagging basis,” says Lee Frush, a certified financial planner at Cornerstone Financial, an Atlanta-based private wealth management and planning firm. “A tempered and sustained growth pattern in the U.S. could be good for EM economies, too.”

Frush takes solace in historical patterns. Emerging markets, he points out, suffered between 1999 and 2003, then rallied sharply for two straight years. “Today, even if values languish for several years, it provides an excellent opportunity to pick up shares at depressed values,” he insists.