5 Reasons to Buy Emerging Markets Stocks

The recent stock market selloff inflicted pain almost everywhere. But, in a surprise to many on Wall Street, it caused the most suffering among investors in emerging markets -- arguably the healthiest part of the global economy.

Look at the numbers. From April 29 through October 3, Standard & Poor’s 500-stock index of mainly large U.S. companies lost 18.6%. Over the same period, the MSCI Emerging Markets index tumbled 28.1% So far this year through October 18, the S&P 500 has dipped 1.0% while the emerging markets index has plunged 17.8%

What happened? Investors opened their eyes to a host of problems that they had previously overlooked. Among them: The economic slump in the developed world has weakened demand for exports from developing nations. Many emerging markets, notably China, are battling rising inflation, a process that’s slowing growth. Most emerging countries are rife with corruption. Corporate accounting is often opaque at best, fraudulent at worst. Governments own huge stakes in many companies; Russia, in particular, has a long history of hostility toward capitalism.

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When will the bear market in emerging markets end? Count on emerging markets to continue to move in much the same direction as developed markets -- but to be much more volatile. That’s how they’ve behaved, with few exceptions, for decades. At any rate, now is a great time to invest in emerging-markets stocks. Here are five reasons:

1. Emerging-markets stocks are cheap. Buying stocks when they’re inexpensive doesn’t guarantee you’ll make money, but it sure boosts your odds. The MSCI Emerging Markets index currently trades at 10 times analysts’ forecast earnings for the next 12 months. By contrast, the S&P trades at 12 times estimated earnings.

Emerging-markets stocks aren’t just cheap based on earnings estimates. The MSCI index trades at just 1.5 times book value (assets minus liabilities) and 0.9 times revenues for the past 12 months. The index yields 3.3%. These are table-pounding numbers.

2. Emerging markets are still the fastest-growing part of the global economy. Emerging economies will grow 6.4% this year, compared with 1.6% for advanced economies, the International Monetary Fund forecasts. Since the start of 2008, emerging nations have been responsible for fully 85% of all global growth.

Rapid growth, moreover, is turbo-charging corporate profits. Analysts expect the MSCI Emerging Markets index to show a 16.5% gain in earnings per share this year and a 12% increase in 2012. And companies in developing nations are expected to raise dividends by 10%, on average, each year.

What’s more, emerging nations are, as a group, in far better fiscal shape than the developed world, the IMF says. Government debt in emerging countries averages 35% of gross domestic product. In developed nations, the average debt-to-GDP ratio is about three times higher. Being fiscally sound should help emerging markets continue to grow and is also likely to boost the value of their currencies versus the dollar -- a plus for U.S. investors in emerging-markets stocks (when the greenback weakens against a currency, money invested in that currency gets translated into more bucks).

3. Demographics favor emerging nations. As the U.S. population ages, more people are relying on government benefits, and fewer people are entering the workforce and starting to pay taxes. It’s the same story in Japan and Western Europe. But the opposite is true in emerging markets. In most of those countries, the population, on average, is young and just entering the workforce.

4. Globalization isn’t going to slow down. Attempting to stop international trade is economically foolish and ultimately impossible. It’s akin to fighting gravity. Continued advances in technology make it good business to move more work to developing countries, where wages are lower than they are in the U.S. and other established nations.

5. It’s not all about exports. Consider China, which Standard & Poor’s estimates will grow 8.8% this year. Exports last year amounted to 27% of China’s GDP -- down from 35% in 2007. Falling exports, caused by a slowdown in demand from overseas, will likely reduce China’s GDP growth by just one percentage point in 2012, UBS predicts.

The point is this: A vast new middle class is emerging in emerging nations, and those aspiring citizens are eager for the goods and services that once only the wealthy in those countries could afford. As this middle class grows, emerging markets will increasingly become less dependent on exports to the developed world.

But for years to come, emerging-markets stocks will move in tandem with those in the developed world -- only with more volatility. That doesn’t mean you should avoid these stocks -- just be prepared for big selloffs along with rapid growth.

As far as investing, I can’t find a single no-load emerging-markets fund to strongly recommend. Stick with a broad-based index fund. My favorite is Vanguard MSCI Emerging Markets ETF (symbol VWO), with an expense ratio of just 0.22% annually. (T. Rowe Price Emerging Markets Stock -- PRMSX -- is a member of the Kiplinger 25, a list of Kiplinger’s favorite no-load mutual funds.)

Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.