In the early part of this century, emerging market equities were all the rage. And those stocks delivered on the hype. But following the global financial crisis, a lengthy era of outperformance by domestic equities was ushered in.
So clear was the leadership of U.S. stocks and laggard status of emerging markets equivalents that advisors and investors had little motivation to take on the added risk associated with the latter. That script maybe flipping. There’s much more of 2025 to go. But it’s clear the MSCI Emerging Markets Index is in the green to start the year, while S&P 500 is not.
Count the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE ) among the ETFs tracking developing-world stocks that’s also beating the S&P 500 to start 2025. As its name implies, XSOE eschews exposure to state-run companies. That group is known for slower rates of growth in the emerging market complex. That avoidance could be a positive if emerging market stocks extend recent bullishness over the duration of 2025.
Why XSOE Could Excel
Valuation has long been the battle cry of emerging market equity supporters. And in what could be good news for those considering XSOE, the asset class remains attractive on that basis.
“For years now, emerging-markets stocks have traded at a deep valuation discount to their US counterparts,” noted Morningstar analyst Dan Lefkovitz. “The trailing 12-month price/earnings ratio on the Morningstar Emerging Markets Index was just 14.0 as of the end of 2024, compared with 26.4 for US stocks. We saw an even bigger gap in 2021 when the US traded at twice the multiple of emerging-markets stocks.”
Those inviting multiples are pertinent when evaluating XSOE. That’s because the ETF allocates 21.43% of its roster to India stocks, which have long been viewed as expensive. Additionally, the ETF devotes 31.15% of its weight to tech stocks. But the good news is emerging market growth names, broadly speaking, trade at noticeable discounts to domestic equivalents.
Another factor that could work in favor of XSOE is declining correlations between emerging market stocks and U.S. monetary policy. There was a time when those stocks were highly dependent on favorable interest rates in the U.S. But that’s waning, and that could be a good thing. That’s because the Federal Reserve may not have the room to lower rates much, if at all, in 2025.
A Weakened Link?
“The link between emerging-markets’ performance and US interest rates looks to have weakened. The Morningstar Emerging Markets Index outperformed only marginally in 2020 after global central banks responded to the pandemic with rate cuts,” added Lefkovitz. “And in the bear market of 2022, emerging-markets equities declined in line with their developed counterparts, despite the most aggressive rate hikes in a generation.”
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