There’s no sugarcoating it: 2018 was hard on emerging markets. But as Nietzsche (and Kelly Clarkson) said, what doesn’t kill you can make you stronger. And as 2019 begins, we see many pockets of strength—and opportunity.

There are still headwinds buffeting emerging-market debt (EMD), as there are with all risk assets. Interest rates are rising, the US dollar is strong and market liquidity is declining. In these conditions, investors can’t afford to chase high yields while ignoring an asset’s underlying fundamentals.

Happily, fundamentals in much of the EMD universe are still strong, leaving the sector well insulated against external shocks in 2019. And after last year’s sell-off, valuations are attractive. Consider the positives:

1. EM countries are still the world’s most powerful growth engine. In a world of slowing growth, emerging markets are expanding more rapidly than developed ones—and they’re likely to widen the gap in the years ahead. The International Monetary Fund (IMF) forecast that EM economies would grow 4.7% in 2018, well above the 2.4% rate of the world’s advanced economies. And this growth differential is expected to widen in the years ahead.

While we expect global growth to slow somewhat in 2019, we think much of this expectation is already priced into EM assets.

2. External vulnerabilities have declined considerably. In the past, large current account deficits throughout developing economies meant many were wholly dependent on foreign investors for their short-term financing. That’s not the case today. Outside of a few outlier countries, emerging markets have reduced current account deficits and attracted more foreign direct investment—a more stable source of financing because it is usually long-term in nature.

3. Valuations are compelling—historically and relative to other risk assets. After 2018’s sell-off, asset valuations for bonds and currencies are broadly attractive. EM currencies are trading well below their historical long-term average, while the US dollar looks overvalued and unlikely to appreciate so rapidly the coming year with US economic growth expected to slow to trend. And last year’s broad sell-off has left EM bond spreads—the extra yield these assets offer over US Treasuries—substantially wider than they were 12 months ago. That means they’ll provide more cushion than they did in 2018 as US interest rates rise (Display).

Real yields are near historical highs relative to those on developed-market (DM) bonds, and high-yield EM sovereigns have rarely traded at a higher premium to US high-yield corporate bonds. (Display)