After last week’s smooth ride, this week was a bit bumpier.
Over the last few years, emerging markets haven’t exactly lived up to their promise. Investors typically turn to the faster-moving nations as they are in the beginning stages of their economic development. This led to soaring gains in the late nineties and through the credit crash and Great Recession.
However, a myriad of factors have kept nations like China, Brazil and South Africa down over the last few years. Much of the developing markets’ promise has gone unfilled.
But times are starting to change, and stocks in developing nations are, once again, on the rise. For dividend investors, this is a particularly interesting time as emerging markets offer some pretty good opportunities. However, these opportunities won’t last long as stocks in these regions begin to surge.
Hitting a Wall
Travel back in time to the end of the dotcom boom. It’s here – when China and the rest of its emerging market cohorts began to get cooking. Economic development, rising middle classes and higher commodity prices/infrastructure development drove shares of stocks in developing regions. Between their low, after the dotcom bust in March 2003, and their peak, in October 2007, emerging markets, as represented by the iShares MSCI Emerging Markets ETF (EEM), surged more than five-fold.
And then the bottom fell out.
The credit crisis and global recession were very hard on the developing world and the MSCI index decreased by more than 60%. The reasons for the drop were varied. For one thing, commodity prices were decimated and left many nations who profited from natural resource wealth – such as Chile or Peru – suffering. Credit became hard to come by for others, while the surging dollar – thanks to its safe-haven status – made life even more challenging.
All of these issues, plus plenty of political uncertainty, caused investors to abandon emerging markets. And aside from a post-recession snap back, the 23 nations that make up the developing world have basically done nothing but drift lower. The MSCI is now about 20% below its last peak, realized in 2011.
All that said, things are starting to grind forward.
After U.S. stocks continued to rise – and rise some more – investors are beginning to embrace emerging markets once again. Many of the reasons why investors loved them in the first place, such as rising middle-class wealth and large younger populations, remain in place, while several of the catalysts that were holding them down have been removed. The dollar has finally started to sink, while commodity prices continue to rise. This has loaded the developing world’s gun once again.
Pulling the trigger has been their cheapness. Emerging markets can roughly be had for the cyclically adjusted price-to-earnings ratio (CAPE) of about 14, while the U.S.-focused S&P 500 is currently at an eye-popping 28.5. Emerging markets’ cheapness is further highlighted in the following chart by bond guru Jeffrey Gundlach. It turns out investors are paying quite a bit for U.S. stocks when looking at their book values. Developing markets? Not so much.
Source: Doubleline Investments
With this in mind, the shift is on. Over the first quarter, emerging markets stocks have surged 11.4%. This has been the best performance for the sector since 2012 when they stalled out and began their new multi-year slump.
Why Dividends Now?
For dividend investors, this time seems particularly urgent. Even with the gains, emerging markets stocks are still pretty cheap when compared to their developed rivals. But remember, these are emerging markets. Their history has been fraught with periods of boom and bust, but the long-term picture is rosy. Data from insurer Zurich shows that over a 20-year period, emerging markets have returned about 6.5% a year. This compares to the average 4.5% per year that developed markets have produced. The problem is that the emerging markets ride has been much more dramatic with its swings.
As we know, dividends are a great way to smooth out that bumpiness and reduce the overall volatility of a portfolio. In the emerging world, that’s particularly important. Getting 3 to 4% in cash can go a long way to helping your returns. Even better is that the emerging world generally has a friendly dividend culture. Thanks to high family or state ownership structures, yields tend to be higher in developing nations than in domestic ones.
With the sector still cheap and dividends still plentiful, longer-term investors have a short window to “cash in” for the long haul and protect their portfolio with these dividends.
How to Do It
Given the complexities of researching, say, stocks in Thailand or Poland, this is one instance where investors may want to leave it to the professionals, or at least to the index providers. Here, investors can add a large swath of dividend-paying emerging markets stocks without having to break a sweat.
An excellent choice is the WisdomTree Emerging Markets High Dividend Fund (DEM). Among the emerging markets ETFs, DEM has the longest-operating history, at over ten years, and has close to $2 billion worth of assets. It spreads those assets among roughly 400 different high-yielding emerging markets stocks. Top nations include Taiwan, Russia and China. However, the ETF is pretty balanced with regard to overall exposure. The focus on high yield gives DEM a juicy yield of 3.29%. Moreover, it’s allowed DEM to return more than 15% since its inception when including dividends. That’s versus 1.70% for the previously mentioned EEM. It’s been less volatile as well.
The Bottom Line
After years of flatlining, emerging markets are coming back. Investors should prepare for their rise by adding a dose of developing market dividends. The steady payouts will help cushion the volatile nature of the sector while helping drive returns.