3 Reasons iShares MSCI Emerging Markets ETF (EEM) Could Rise

Emerging markets have lagged behind the U.S. market, but that trend could reverse itself.

Aug 22, 2014 at 7:45PM

Credit: epSos .de via Flickr.

Traditionally, growth-oriented investors have looked to emerging markets for fast-paced opportunities that more established, mature markets lack, and in the early and mid-2000s, emerging-market investments like the iShares MSCI Emerging Markets ETF (NYSEMKT:EEM) delivered extremely strong returns to early investors in the space. In 2013, though, emerging markets performed horribly, faring far worse than U.S. stocks and markets in other developed-economy countries. Even after a good rebound in 2014, investors aren't sure what the future holds for emerging markets generally and the iShares ETF in particular.

Despite its recent turbulence, the iShares MSCI Emerging Markets ETF has plenty of things going for it, and there are good reasons to expect that share prices for the ETF could rise in the near future. With an expense ratio of 0.67%, the ETF isn't as cheap as its Vanguard FTSE Emerging Markets ETF (NYSEMKT:VWO) counterpart, but it does compare well against actively managed emerging-market mutual funds from an expense standpoint. The following three factors aren't guaranteed to push the ETF higher, but if they come to pass, they're likely to have a positive impact on its future prospects.

Brazil has been an important emerging market for investors. Image source: Charlie Phillips via Flickr.

1. Emerging markets are at attractive valuations right now

Like all investments, emerging-market stocks have fallen in and out of favor in cycles. During 2013, concerns about the viability of the global economic recovery led many emerging-market investors to seek the security of U.S. stocks, instead helping to send the Dow up 26.5% even as emerging markets lost money. According to figures earlier this month from The Wall Street Journal, earnings multiple for emerging-markets stocks were just 13.4 -- five full points below the 18.4 multiple for the U.S. stock market.

Many value investors have complained that U.S. stocks no longer present compelling reasons to invest, especially for those demanding a margin of safety. Emerging markets have greater political risk than U.S. stocks, and they're also more vulnerable to economic disruptions, so some discount in price-to-earnings multiples is reasonable. But given such a large disparity, bargain-seeking investors could increasingly gravitate toward emerging-market stocks and the iShares ETF in particular.

2. Key emerging-market countries like China and Brazil are showing potential signs of economic strength

Emerging-market stocks are also vulnerable to slowing economies, and expectations from emerging-market economies remain high. Chinese GDP growth remains well above levels in the developed world, with forecasts for 7% to 8% growth over the next year or so. But Brazil has struggled much more, and growth rates have fallen into the 1% to 2% range. Those problems led to investor uncertainty about long-term future prospects.

China Flag
Source: Wikimedia Commons.

Even now, economic data presents a mixed picture for the immediately future. But some signs of improvement have emerged, as growing middle-class consumer bases create a foundation for sustainable long-term growth for the domestic economies of major emerging-market nations. Admittedly, the export-driven nature of emerging-market economies leaves them vulnerable to slackening demand from struggling areas of the developed-market world, such as Europe, but as wages improve and economies mature, emerging markets should become more stable and build more resistance to normal oscillations in the business cycle.

3. Investor sentiment is driving demand for popular emerging-market investments, sparking momentum

ETFs in particular can move based on investor sentiment, and 2014 has been a much better year than 2013 for the iShares MSCI Emerging Markets ETF and other similar funds. Overall, inflows into emerging-market ETFs followed their gains early in the year, and by April, more money had come into the emerging market sector than at any point during the previous year. Those trends have only continued in more recent months as investors look for alternatives to soaring U.S. stocks.

Some still remain concerned that low U.S. interest rates have spurred greater investment in emerging markets, and therefore that future rate hikes could reverse those capital flows and hurt emerging markets. For now, though, investors appear more confident about prospects for the iShares ETF and other emerging-market investments, and their confidence has helped create a positive feedback loop for share prices.

Overall, you can expect the iShares MSCI Emerging Markets ETF to track the general performance of major markets like China, South Korea, and Brazil, along with other important emerging economies around the world. If those areas fare well, then share prices could easily maintain the positive momentum they've seen so far in 2014.

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