Over the past year, emerging market (EM) equities have been one of the most volatile segments of the global market. With news headlines dominated by the International Monetary Fund’s bailout of Argentina and Turkey’s sudden interest rate increase and currency depreciation, EM equities dramatically sold off in 2018 – down 14.6% for the year (source: MSCI Emerging Markets Index). Investors sold billions of dollars of EM equities and market pundits raced to declare an EM crisis, one worse than 2014 and perhaps on par with 1997–1998. The fear has been palpable.

However, at Research Affiliates and PIMCO, we see two overarching reasons for long-term investors to consider continuing to hold a strategic allocation to EM equities: fundamentals and valuations.

Fundamentals don’t justify the fear

In our view, the biggest risk when investing in an EM equity market is a funding crisis, when a company or government borrows in U.S. dollars and investors lose trust in its ability to cover interest payments. We think the risk of a broad-based funding crisis in EM, especially the kind that affects the largest EM equity markets, is low.

First, the global economy, although decelerating, remains in many ways more stable than it has been in decades: Poverty has declined, inflation has trended downward and crises in banking, currency or sovereign debt have been less frequent. Second, since 2000, major EM countries have become wealthier and financially healthier as measured by cumulative GDP growth: China is up 60%, India 41%, South Korea 24% and Taiwan 22%. And as wealth has increased, foreign exchange (FX) reserves have grown – the average EM reserve level is approaching 25% of GDP today. (All data is from Research Affiliates and the World Bank.)