It may seem like a poor environment for EM stocks, but they outperformed in the recent volatility. Russ explains why.

Global stocks are testing the fall lows, the VIX is over 25 and oil continues to collapse–not the ideal environment for emerging market (EM) stocks. Yet, while EM equities have traded lower–along with every other risky asset–they are outperforming developed markets (see Chart 1).

EmergingFinal

In August, I suggested that EM stocks were beginning to look like that rarest of things in an aging bull market: a bargain. My timing, to be generous, was early. From the late July peak to the fall bottom emerging markets equities lost another 15%.

However, more recently EM stocks have been outperforming. Given the litany of concerns, from a trade war to tighter financial conditions, why are EMs outperforming and can it continue? Three factors to consider.

1. Still cheap, getting cheaper.

Emerging market stocks were inexpensive in July; they are cheaper today. Based on trailing earnings, the price-to-earnings (P/E) ratio has dropped from 13.1 to 12, the cheapest since late 2015. On a relative basis, the MSCI Emerging Market Index is still trading at a 30% discount to developed markets, close to the bottom of this cycle’s range.

2. A more range-bound dollar.

After rallying 10% from the February low to the August high, the rally has started to stall. While the Dollar Index (DXY) did make a nominal high in mid-November, more recently the index has been stuck around 96-97. This is important. In the post crisis-world a rising dollar has been associated with weaker EM returns. Since 2010, monthly changes in the dollar have explained roughly 30% of the variation in emerging market equity returns. A flat dollar removes a key headwind.