Will the Emerging Markets Rally Continue in 2017?

A Look at How Emerging Markets Will Fare Next Year

Getty Images / Monty Rakusen.

Emerging markets considerably outperformed developed economies in 2016 thanks to improving fundamentals and low interest rates. While the Federal Reserve’s expected interest rates hikes could take a toll, many experts believe that emerging markets could extend their rally into 2017 given stabilizing commodity prices, growing consumer markets, and favorable valuations relative to developed markets around the world.

In this article, we will take a closer look at the strong performance in emerging markets throughout 2016, where they may be headed in 2017 and beyond, as well as the best strategies for investors looking to increase their exposure to the asset class.

Strong Performance in 2016

The iShares MSCI Emerging Markets Index ETF (NYSE ARCA: EEM) — the most popular emerging markets ETF — jumped about 8.76 percent between January 8 and December 30, 2016. By comparison, the iShares MSCI EAFE Index Fund ETF (NYSE ARCA: EFA) — which tracks developed economies around the world — fell 1.69 percent over the same timeframe. The U.S. S&P 500 SPDR (NYSE ARCA: SPY) fared slightly better with a roughly 9.64 percent rise over the period.

According to WisdomTree Asset Allocation Strategist Joseph Tenaglia, the U.S. Federal Reserve has been a consistent catalyst behind the increase. Investors expected four incremental interest rate hikes throughout 2016, but the central bank didn’t make any moves until December.

This led to a rally in emerging market currencies and improvements in commodity prices, since the U.S. dollar remained relatively weak in comparison.

BlackRock analysts Jeff Shen, Ph.D., and Gerardo Rodriguez further point out that economic fundamentals in the region are improving. Current account deficits have become surpluses; manufacturing activity turned positive; and, gross domestic product (GDP) forecasts have started to improve after four years of downward revisions.

These efforts have been boosted by monetary and fiscal stimulus designed to stabilize growth.

Uneven Outlook in 2017

The emerging markets rally has been somewhat uneven in 2016. For example, the iShares FTSE/Xinhua China 25 Index ETF (NYSE ARCA: FXI) fell 1.63 percent, through December 30, 2016, compared to a nearly 50.57 percent increase in the iShares MSCI Russia Capped ETF (NYSE ARCA: ERUS). While China’s economy has been struggling with growth, Russia’s economy has benefited from stabilizing oil prices and the election of Donald Trump as President.

The top-performing emerging markets include:

  • iShares MSCI Russia Capped ETF (NYSE ARCA: ERUS): +50.57 percent
  • iShares MSCI Thailand Capped ETF (NYSE ARCA: THD): +22.94 percent
  • iShares MSCI Indonesia ETF (NYSE ARCA: EIDO): +15.61 percent
  • iShares MSCI South Africa ETF (NYSE ARCA: EZA): +12.09 percent

* YTD performance data as of December 30, 2016 from ETFdb.com.

Investors may way to consider fine-tuning their exposure to emerging markets by focusing on specific countries and regions that are best poised to benefit. In other cases, investors may want to consider investing in funds that navigate these dynamics for them. The Baron Emerging Market Fund (BEXFX) and the Virtus Emerging Markets Opportunities Fund (HEMZX) are two traditional mutual funds that have posted robust performance over the years.

In either case, investors should carefully consider the expenses associated with these ETFs and mutual funds, as well as the unique risk factors facing emerging markets in general. Emerging market securities tend to be more volatile than their domestic counterparts, while many emerging markets rely heavily on commodity prices and U.S. interest rate policy.

The Bottom Line

Emerging markets have been strong performers throughout 2016 and appear poised to continue outperforming in 2017. While the Federal Reserve is hiking interest rates, improving fundamentals, attractive valuations, and stabilizing commodity prices should overcome those headwinds next year. The performance will not be even, however, as some emerging markets perform better than others due to a confluence of factors.

Investors may want to consider investing in specific emerging markets rather than the entire asset class — particularly if it’s weighted by market capitalization — or consider actively managed funds that take a hands-on approach.

It’s also important to remember that emerging markets tend to be much riskier than developed markets given their reliance on commodity prices and their susceptibility to U.S. interest rate policies.