Any investor with even a passive interest in foreign stocks has probably heard great things about the world's emerging markets. Given their hefty triple-digit returns in recent years and the likelihood of more gains on the horizon, it's not surprising that this corner of the market has captured so much attention lately.
But why do emerging markets offer such a compelling investment opportunity, and how can investors access these potential gains?
(1.) Looking Abroad for Explosive Growth
In years past, most of the world's stock market value was locked up in the United States. However, trillions of dollars of market wealth has been created overseas in the past decade, and there are now actually more opportunities outside our borders than within.
We may have hundreds of great companies here in the U.S. to choose from -- but there are literally thousands elsewhere around the world. Take banks, for example. In terms of assets, the vast majority of the top banks in the world are foreign-based companies. And the story is similar across most other industries, from retailers to steelmakers to electronics manufacturers -- many of the top players and future bellwethers are located outside the U.S.
And aside from greatly expanding the pool of potential investment ideas, there are plenty of other reasons to look overseas in search of gains. Income-oriented investors can find better interest rate environments and higher yields. Value hunters can go bargain hunting in markets that offer extremely compelling valuation levels. And growth hounds can place their bets in countries where robust economic growth is driving corporate profits sharply higher.
Clearly, there is something to be said for casting a wider net, and those that have done so have been well rewarded. Over the past 15 years, the U.S. has not once been the top-performing stock market in any given calendar year. In 2007, for example, the S&P 500 failed to break the top 50 -- its +3.5% return wasn't even within shouting distance of China's impressive +163% gain or the +135% surge that investors saw in the Ukraine.
Over the past five years, U.S. stocks (as measured by the S&P 500) have delivered average gains of about +7% per year. While that return is respectable, it lags most foreign benchmarks -- stocks have jumped +19% per year in Pacific Asia, +17% per year in Europe, and +43% per year in Latin America over the same time frame.
Investors that want exposure to foreign markets essentially have two broad choices: the developed world or the emerging world. The developed world consists of mature markets in North America, Western Europe and Japan. Meanwhile, less developed nations throughout Asia, Africa, Eastern Europe and Latin America are said to be emerging.
A well-rounded portfolio will include exposure to both of these categories, but of the two, we believe investors should focus their attention on the emerging markets.
As economic expansion in relatively undeveloped nations like China and India continues to unfold, we have witnessed the creation of a flourishing middle class and dramatic growth in consumer spending. At the same time, with a plentiful pool of comparatively inexpensive laborers, many of these countries have also become major manufacturing hubs for everything from plastics to toys to semiconductors. Others, meanwhile, are commodity-rich nations that have been busily exporting billions of dollars worth of oil, copper, iron ore, and other natural resources around the world.
While the story might change from country to country, the overall economic outlook for the developing world is bright. Naturally, this heady growth should translate into tremendous gains for investors in the years ahead. Already, many of the nascent companies on these exchanges have delivered powerful gains. But considering these secular economic growth phases can take decades to play out, there is still time to get in on the ground floor.
(2.) Ride the wave of Increased Economic Power
In the late 19th century, England was the world's preeminent superpower. At the time, many of the world's largest companies were British, and the London Stock Exchange was far and away the world's largest. HowaP/E29er, by 1900 economic growth in the highly developed U.K. had already begun to slow -- the natural consequence of a maturing economy. At the same time, the U.S. was rapidly catching up, evolving from a largely agrarian society into a manufacturing and financial powerhouse.
Fast forward 100 years, and England remains a highly advanced country with a high standard of living, but it is no longer the superpower it once was. Meanwhile, the U.S. has grown steadily to become the most dominant economy on Earth -- with a staggering gross domestic product (GDP).
But like Britain in 1900, the U.S. is now advanced and fully industirlized. As a result, it's unlikely that the country can continue to grow at the same pace it has over the past century. In fact, annual growth of just +3-4% is now considered robust for such a large, developed economy.
However, similar to America at the turn of the century, many emerging markets are still very early in their development cycle and are just now beginning to hit their stride. And just as U.S. stocks have created trillions in wealth over the past few decades, dominant companies in the world's developing markets could do the same in the coming years.
This growth will be fueled by a number of different factors. Asian economies, for example, are becoming important bases for global manufacturing operations. In China, major multi-national companies are taking advantage of low labor costs by moving manufacturing jobs to the country.
Meanwhile, infrastructure throughout Asia continues to grow, and that rapid expansion has led to high demand for basic materials like copper, steel, and energy (oil and natural gas). Prices for these basic commodities are rising to levels unseen in two decades, and as a result, commodity-rich economies across Latin America are benefiting.
At the same time, many emerging markets are enjoying a booming export business. South Korea, for example, is a world-class manufacturer of ships and automobiles, as well as semiconductors, wireless equipment, and other electronics. Driven by strong demand from nearby China, as well as consumers in the Western world, the exportation of these products has surged, pushing the country's GDP above $1 trillion.
Finally, many emerging markets are also benefiting from regulatory reforms, cross-border trade, and loose monetary policy. And of course, as the disposable incomes in these densely populated regions continue to rise, we expect these nations to see sustained growth in consumer spending power in the years ahead, boosting earnings for retailers, financial services providers, and a host of other industry groups.
Overall, mature economies like England and the Unites States are expected to grow around +2-3% annually over the long term, while those in places like Russia, India, China and Hong Kong are expanding as much as four times faster. Going forward, this growth should translate into superior corporate profitability and impressive gains for investors.
However, keep in mind that these stocks and the associated ETFs can be quite volatile. And anything from inflationary pressures to rising interest rates to signs of a global economic cool-down could send them tumbling. Investors should also note that emerging markets carry other unique risks, such as political upheaval, regulatory changes, and currency fluctuations.
But there is no doubt the emerging markets represent some of the best opportunities for ETF investors over the long term.
