This is a difficult time for international stocks, especially in developing countries. At the moment, political and market events in Turkey are sparking volatility across emerging markets. These and other investor concerns have led emerging market stocks to underperform the U.S. by 14% year-to-date and have kept a lid on U.S. interest rates. While developments are on-going, it’s important to keep these types of market episodes in perspective.
Just as in the case of Argentina’s depreciating peso, most investor concerns are specific to Turkey itself. In particular, Turkey failed to increase interest rates to defend its plummeting currency, it runs significant deficits fueled by U.S. dollar-denominated debt, and faces heightened tariffs from the Trump administration. Ultimately, Turkey is a rather small component of the emerging market index, let alone the world stock market.
This doesn’t mean there won’t continue to be market volatility as a result of contagion effects – that is, the fear that problems in Turkey will spread to other parts of the market. While there may be limited economic contagion, there has already been market and financial contagion as investors attempt to assess these developments. Just as investors reacted to problems in Greece over the past decade, China in 2015, and the “fragile five” currencies in 2013, they will continue to spur market volatility during this episode.
If many of these problems do prove to be country-specific, limiting the contagion effect, then investors will be justified in focusing on longer-term trends. International markets are still quite attractive, both in terms of valuations and fundamentals. At the moment, emerging markets are expecting nearly as much earnings growth as U.S. large cap companies, but are trading at a significant discount. Even if conditions in places such as Turkey and Argentina worsen, they are unlikely to change the trajectory of overall emerging market fundamentals.
1. Emerging market currencies have been fragile
The Turkish lira has plummeted in recent days and continues to face trouble from a variety of country-specific and international factors. A weaker currency is problematic since the Turkish government and its businesses binged on cheap U.S. dollar-denominated debt over the past several years. Additionally, Turkey faces heightened inflation concerns which only worsen if its currency falls in value.
Some of these concerns have also spread to other emerging market currencies, many of which have their own specific challenges. Still, the broader outlook for emerging markets is positive, based on valuations and expected growth in earnings.
2. Emerging market earnings growth is still strong
While the media are focused on country-specific headlines, the true driver of long-run returns are valuations and earnings. Currently, analysts expect 13% earnings-per-share growth for the overall emerging markets index over the next twelve months. This is a healthy growth rate that is nearly as strong as U.S. large cap stocks, which should continue to drive returns.
3. Global valuations are still attractive
Emerging markets continue to be the most attractively valued region. As this bull market cycle matures, it’s important for investors to stay globally diversified. There are still attractive opportunities in international markets despite current challenges.
The chart above shows the differences in valuations across the three main stock market regions. The U.S. stock market, having risen significantly over the past nine years, sports the top P/E ratios. While there may be shorter-term concerns driving markets today, buying stocks when valuations are cheap has historically increased the odds of success. Thus, with global growth continuing, it’s still an opportune time for investors to be internationally diversified.