Emerging Market ETFs Look Cheap

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Includes: FNDE, PXH
by: Tom Lydon

Summary

U.S. equities look fairly priced, if not overvalued, as the bull rally continues.

Investors who want to find cheap investment opportunities should look at the emerging markets.

Factors that could help support the emerging markets.

Investors who are seeking cheaper plays in today's markets will have to look to emerging market exchange-traded funds where valuations are more attractive than U.S. equities.

"There's a [wide range] of markets available to us and some are pretty cheap," Research Affiliates Chairman and CEO Rob Arnott said in a Bloomberg article. "Emerging market stocks are priced at 15 times their 10-year earnings. If you use a fundamental index, they're priced at 11 times their 10-year earnings. Eleven times. That's cheap."

For instance, the Schwab Fundamental Emerging Markets Large Company ETF (NYSEArca: FNDE) has a price-to-earnings ratio of 10.0 and a price-to-book of 1.0. FNDE tries to reflect the performance of the Russell Fundamental Emerging Markets Large Company Index, which uses indexing methodologies developed by Research Affiliates, and selects components based on three fundamental measures of company size, including retained operating cash flow, adjusted sales, and dividends plus buybacks.

Additionally, the PowerShares FTSE RAFI Emerging Markets Portfolio ETF (NYSEArca: PXH) has a P/E of 9.8 and a P/B of 1.1. PXH reflects the performance of the FTSE RAFI Emerging Markets Index and selects components based on book value, cash flow, sales and dividends. Companies with the highest fundamental strength are allotted a higher ranking.

Arnott points to the favorable demographics in the emerging markets as a major driver for economic growth. Specifically, developed economies with a mature labor force will remain prosperous but slow-growing. However, emerging markets with a young population and rapidly growing skill set still have untapped potential.

"Emerging economies of the world are right at the sweet spot for GDP growth," Arnott added. "The median age in the emerging markets is 30. In the developed world, [it's] 43."

Arnott also argues that investors are too concerned with chasing yields and shunning underperforming areas. However, there is a greater chance for underperforming markets to pick up speed, while outperforming areas slow down. In the current environment, emerging markets may be a good contrarian play. Year-to-date, FNDE has declined 16.0% and PXH fell 12.5%, whereas the S&P 500 rose 8.9%.

"Human nature conditions us to chase what has performed best," Arnott said. "What has performed best feels good. And yet any student of the market knows that's a dumb way to invest."

Max Chen contributed to this article.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.