Koesterich Still Likes Emerging Markets

Emerging markets equities and plenty of the corresponding ETFs have had quite the run. Even with today's slide of 0.75 percent, the iShares MSCI Emerging Markets Index Fund (NYSE:EEM) is up 16 percent over the past six months. The SPDR S&P 500 (NYSE:SPY) has returned 9.6 percent over the same time.

Predictably, the recent bullishness in emerging markets stocks has left some market participants wondering if there is more gas in the tank for this asset class or if it is now too late to get involved. iShares Global Chief Investment Strategist Russ Koesterich still sees value in the developing world. Evidence of superior growth is again mounting and that is just one reason to consider emerging markets, in Koesterich's view.

"The growth outlook for emerging markets has improved in recent months," said Koesterich in a blog post. "While China and other large emerging market countries are highly unlikely to achieve double-digit growth anytime soon, or ever, their growth should be higher in 2013."

Not surprisingly, China has been a driving force behind the recent surge in emerging markets stocks and ETFs. For much of 2012, investors fretted that the world's second-largest economy would be unable to avoid an economic hard landing and that the market was having a hard time coming to grips with China's new normal, which includes GDP growth rates unlikely to see 10 percent or anytime soon.

Those concerns have been eradicated in recent months as Chinese economic data, including PMI and export numbers, have consistently improved. Along the way, the iShares FTSE China 25 Index Fund (NYSE:FXI), the largest China ETF by assets, has surged 15 percent.

Other China ETFs such as the iShares MSCI China Index Fund (NYSE:MCHI), the SPDR S&P China ETF (NYSE:GXC) and the Guggenheim China Small-Cap ETF (NYSE:HAO) have participated in the rally as well.

Even after the stellar performances turned in by developing markets stocks over the past few months, the group remains inexpensive on a valuation basis, notes Koesterich.

"Based on price-to-earnings ratios, developed markets are trading at a 50% premium to emerging markets, the largest such premium since late 2009," according to the strategist. "And historically, premiums this large have generally been associated with emerging market outperformance over the next twelve months."

One of the markets Koesterich identifies as attractively valued is one that has been wearing that label for quite a while now: Brazil. In 2012, the iShares MSCI Brazil Index Fund (NYSE:EWZ), the largest ETF tracking Latin America's largest economy, languished and was the worst performer among the four major ETFs devoted to the BRIC nations.

There is no other way of saying it than that EWZ was one of the most disappointing emerging markets ETFs of 2012. Slowing growth and an often unfavorable business climate for Western companies are strikes against Brazil.

However, EWZ has surged 7.4 percent over the past month and Koesterich sees opportunity.

"Of all the large emerging markets Brazil is one of the cheapest, with the market trading at less than 10x forward earnings and barely 1x book value," said Koesterich. "Valuations at this level look particularly attractive given the country's current inflation rate of 5.5%, a moderate rate for Brazil. Assuming Brazil's inflation remains at current levels and the country's growth picks up this year as I expect, valuations have significant room to expand. I also believe that Brazilian equities' recent sluggishness is a sign that investors haven't given the market proper credit for recent structural reforms."

Koesterich highlighted Brazil, China and Russia as options "for investors seeking a less volatile strategy." The one ETF directly mentioned in his post was the highly popular iShares MSCI Emerging Markets Minimum Volatility Index Fund (NYSE:EEMV). EEMV has attracted more than $889 million in assets in less than 16 months of trading and has returned 18.4 percent over the past year.

For more on emerging markets ETFs, click here.

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