Investing in Emerging Market Equities During the COVID-19 Crisis

The COVID-19 pandemic began in China before spreading to Europe and North America. While Europe and North America were the first to suffer severe outbreaks outside of China, several emerging markets have seen a significant increase in case load and deaths in June and July. These outbreaks are especially dire because these countries don’t have as well-equipped public health systems or access to healthcare.

The latest case load data, as of July 23, 2020, include:

• Russia’s case load reached 15.3 million with 624,000 deaths.
• Brazil’s case load hit 2.23 million with 82,890 deaths.
• South Africa’s case load reached 395,000 with nearly 6000 deaths.
• India’s case load reached 60,000 with nearly 2,900 deaths.

The combination of worsening domestic conditions and reduced export demand for emerging market goods, namely commodities, has pushed equity valuations to extreme lows. For example, Morgan Stanley found that emerging market equities were about 44% below their long-term nominal return trendline, representing a two standard deviation low only matched during the 1980s and the 2001/2002 recession.

Source: Morgan Stanley

Emerging market forward price-earnings ratios remain well-below 22.8x for the U.S. and 17.8x for the E.U., according to Yardeni Research. While Asian P/E ratios averaged 15.4x and Latin American P/E ratios averaged 15.9x, Eastern European P/E ratios averaged just 8.7x with Russian equities averaged at 8×. Worsening public health outcomes could further depress P/E ratios over the coming months.

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Most investors maintain a diversified portfolio consisting of both developed and emerging markets. Prior to the pandemic, many investors held a moderate view on emerging markets due to their fairly high valuations and higher risk. The COVID-19 outbreak led to a sharp drop in many emerging market valuations, especially in comparison to potentially lofty developed market valuations.

Source: Multpl

China has become a potentially attractive emerging market opportunity thanks to its modest equity valuations and success in containing COVID-19 after an initial outbreak. While the country has seen an escalating trade war with the U.S., it’s a key supplier to countless other markets around the world and has a growing domestic consumption base that could fuel its recovery.

Other emerging markets may be riskier. For example, Indian equity valuations stand at 22.2x, which is higher than other major emerging markets, despite an accelerating domestic COVID-19 outbreak. Investors may want to consider reducing their exposure to Indian equities, while increasing their exposure to other key emerging markets with more reasonable valuations.

The performance of emerging market mutual funds has been mixed over the past year. While broad emerging market funds have experienced modest losses, Chinese funds have seen strong gains while Latin America and other regions have seen sharp losses over the same period. Check out some of the fund performances below.

• YTD is January 1 – July 23, 2020.

When evaluating mutual funds, investors should take into account both fundamental criteria, such as P/E ratios, and expense ratios, turnover, liquidity and other more technical concerns.

Don’t forget to check out emerging market funds here.

The COVID-19 pandemic has led to a sharp contraction in equity prices and valuations across many countries—including emerging markets. With emerging market valuations falling to their lowest levels in years, many investors have increased allocations to some markets while avoiding those that are experiencing significant outbreaks.

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