Emerging-market stocks have experienced a nine-month run of gains, the longest streak since 2004, driven by strong inflows and high demand for Asian tech shares. A weak dollar and Federal Reserve rate cuts have been key factors in this trend, with Chinese tech shares also performing well.
The iShares MSCI Emerging Markets ETF (EEM) has risen 29.5% this year, outperforming the S&P 500’s 14.5% increase. Emerging markets have remained undervalued, with the EEM carrying a P/E ratio of 16.33X compared to higher ratios for U.S. counterparts.
Emerging Economies and Consumer Price Growth
Emerging economies such as India, China, and Brazil are seeing reduced consumer-price growth, lessening the requirement for interest rate hikes. In India, significant rate cuts have already occurred, while China’s investment in AI has contributed to a robust tech sector, although Chinese tech shares remain cheaper than their U.S. counterparts.
P/E ratios for Chinese tech ETFs remain lower than U.S. ones, as evidenced by the Invesco China Technology ETF (CQQQ) versus the iShares U.S. Technology ETF (IYW). A variety of emerging market ETFs outperformed the S&P 500 this year, maintaining low P/E ratios and substantial market value, largely influenced by Chinese content.
Given that emerging-market stocks have now posted nine straight months of gains, we should view this not as an end, but as a sign of persistent momentum. The primary drivers for this trend, a weakening U.S. dollar and the Federal Reserve’s recent rate cut in September, appear set to continue. This macro environment strongly suggests maintaining a bullish outlook on emerging markets.
For the coming weeks, we should consider buying call options on broad-based ETFs like the iShares MSCI Emerging Markets ETF (EEM) to leverage this upward trend. Yesterday’s U.S. jobs report for September showed weaker-than-expected hiring, which only strengthens the case for another Fed rate cut before year-end and adds more downward pressure on the dollar. This makes long positions on emerging market assets even more attractive right now.
Market Valuation and Trading Strategies
The valuation gap between emerging markets and the U.S. remains significant, providing a cushion. With the CBOE Emerging Markets ETF Volatility Index (VXEEM) trading near a two-year low of 19, buying call options is relatively inexpensive. Alternatively, for a more conservative approach, we can sell put credit spreads on the iShares Core MSCI Emerging Markets ETF (IEMG), collecting premium on the belief that its lower valuation will limit downside.
The Chinese technology sector, particularly in AI, is showing exceptional strength and still appears cheap compared to U.S. tech. With the Invesco China Technology ETF (CQQQ) already up over 50% this year, we can use bull call spreads to participate in further gains while defining our maximum risk. This allows us to stay in a hot market that continues to draw in global investment.
We should also look at the relative performance against U.S. markets. A pairs trade, going long EEM futures and short S&P 500 futures, is a direct way to bet on this divergence continuing. When we last saw a winning streak of this length back in 2004, it preceded a multi-year period where emerging markets massively outperformed developed markets.
Finally, we should not ignore the continued capital flows, as data from the last week of September showed another $4 billion moving into EM equity funds. For the more fundamentally driven ETFs mentioned, like the Schwab Fundamental Emerging Markets Equity ETF (FNDE), selling cash-secured puts at strikes below the current price is a sound strategy. This allows us to either generate income or acquire shares at a discount if a minor pullback occurs.
