Investing: Have emerging markets been oversold?

Investors seem to be hinging their hopes on China, India, and other emerging markets, said Paul Lim in The New York Times. The MSCI Emerging Markets index has climbed more than 60 percent since March, trouncing returns posted by domestic stocks. But “stocks’ behavior in the first two to five months after a bear market can be quite deceiving.” During the early stages of rebound, the sectors that seem to perform best are often those that gained the most during the previous bull market and, subsequently, suffered the most during the bear market. Unfortunately, this “resurgence” is often short-lived, as investors start questioning the fundamentals behind the trend.

In many ways the continued popularity of emerging-market stocks “makes sense,” said William Bernstein in Money. “Developing countries are, after all, expected to lead us out of this global recession.” Yet economic growth doesn’t always translate to stock-market growth. “Politics often gets in the way of equity-market performance, as it did in China 20 years ago, after the Tiananmen Square crackdown.” Moreover, investors can become victims of a country’s success. “As an economy grows, new companies start issuing shares and existing firms sell additional stock, diluting your cut of a country’s earnings.” Besides, the fact that emerging markets promise steep growth “isn’t exactly a secret.” If prices are too optimistic now, future returns will suffer.

“Virtually everyone who has ever put a nickel into emerging markets bears battle scars,” said Steven Goldberg in Kiplinger.com. “The trick in this dicey sector is to hold on—regardless of the short-term pain.” Assuming you’ve got the guts to be in it for the long run, put about 10 percent of your portfolio in an emerging-market fund that tracks the MSCI index or otherwise invests in developing countries. But stay away from funds that focus on one ­country or region. “A diversified emerging­-markets fund will give you all the thrills and spills you can handle.”

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