By Debbie Carlson

Emerging market stocks are posting some of their best gains in years, with the benchmark MSCI Emerging Markets Investable Market Index up 15% year to date. And they are poised to build on the bullish momentum as the Federal Reserve and other central banks cut interest rates.

Combined with cheap valuations, now may be a good time for investors to add a small allocation of emerging market equities to their portfolio. Historically, emerging markets benefit when the Fed cuts rates and engineers a soft landing, says Derrick Irwin, portfolio manager for the Intrinsic Emerging Markets Equity team at Allspring Global Investments.

Economic strength in India and Taiwan has boosted emerging markets, and the sector is riding a tailwind of global liquidity as other big central banks turn dovish. The Fed rate cuts have pressured the U.S. dollar as well. Greenback strength over the past decade had played into emerging market underperformance, Irwin says. The Fed's move also gave some emerging market central banks cover to cut rates, such as in South Africa and Mexico. Post-Fed, China also delivered a big stimulus package to prop up its flagging economy, which recently has boosted emerging market indexes.

The landscape has changed since the early 2000s, when the BRIC countries -- Brazil, Russia, India, and China -- last outperformed. China no longer overshadows other countries as a major index constituent. India now plays a big role, with each country comprising around 21%. South Africa, Mexico, Indonesia, and Thailand are now also in the top 10.

Irwin says the gains in emerging markets will spread beyond India and Taiwan. He sees value in high-quality companies in South Africa and Southeast Asia, where improvement in global liquidity could boost companies' bottom lines.

Todd Rosenbluth, head of research at TMX VettaFi, a data and analytics company, says investors might consider the $3 billion WisdomTree Emerging Markets High Dividend exchange-traded fund (ticker: DEM), which is yielding 5%.

Carlos Sanabria, investment specialist at Signature Estate & Investment Advisors, says if gains in emerging markets continue, an actively managed mutual fund such as the $3.3 billion Driehaus Emerging Markets Growth (DREGX) could benefit. Its managers use a momentum strategy, picking businesses experiencing continuous growth.

The bounce in Chinese stocks following Beijing's stimulus has some investment banks, such as Goldman Sachs, overweighting Chinese shares. Irwin remains underweight the country, waiting to see how China's move eventually affects its economic data. Whether China unleashes more stimulus or not, positive comments from Chinese politicians are just as important since they drive economic policy.

Valuations and macroeconomic tailwinds make a solid argument for a small allocation between 5% to 10% to emerging markets. However, market participants acknowledge that investors may sit out this higher-risk asset class until after the U.S. presidential election. Republican candidate Donald Trump has vowed to put significant tariffs on China.

Steve Conners, founder of Conners Wealth Management, is using two emerging market ETFs that don't include Chinese and Hong Kong markets: the $1.2 billion Columbia EM Core ex-China $(XCEM)$ and the $893 million Freedom 100 Emerging Markets $(FRDM)$.

These diversified funds give investors greater exposure to smaller emerging markets without having to buy single-country funds, he says. He says these funds not only benefit from Fed rate cuts and a weaker dollar, but are also a way to sidestep the potential impact of the U.S. election, regardless of who wins.

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(END) Dow Jones Newswires

October 18, 2024 21:30 ET (01:30 GMT)

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