Top ETF Picks For 2020: iShares MSCI Emerging Markets Small Cap ETF (EEMS)

David Dierking

Note: This is just one in a series of articles talking about my top picks for 2020. I encourage you to check out my other top picks under the "Trade Ideas" tab and look for the "Top ETF Picks For 2020" heading!

At some point, investors are going to need to move away from their overwhelming bias towards U.S. large-caps. If they finally do, they’ll find an environment primed for outperformance by international equities, emerging markets in particular.

The case here is pretty simple - emerging markets offer better growth prospects, better dividend yields, cheaper valuations and they’re starting to get the benefit of a weakening dollar at their back.

While emerging markets are expected to grow around 4% annually, compared to 1% growth expectations for developed markets, it’s the valuation gap that makes a more compelling argument. A chart I like to use often shows how emerging markets forward 5-year returns relative to the S&P 500 are greater as the P/E discount deepens.

Screen Shot 2019-12-19 at 9.25.33 PM

This chart is outdated by a couple years but the statement it makes is clear. The bigger the discount, the greater the EM equity outperformance. The current emerging markets P/E ratio is about 40% below that of the S&P 500. If history holds, emerging markets stand to outperform U.S. equities by about 10-15% annually over the next several years.

And the wheels might already be in motion. After trending higher for more than a year, the dollar has broken below long-term support and sits about 2.5% below its September high.

Screen Shot 2019-12-28 at 3.18.23 PM

Given the backdrop of low growth and the Fed printing billions of dollars in new money every week, the dollar index looks ready to pull back to 95 in the short-term and 92 by the second half of 2020.

All of the pieces are in place for a sustained period of potentially significant outperformance for emerging markets. Not only is this a good bet for 2020, it looks like a strong buy-and-hold candidate for the next five years. EEMS offers a higher risk, higher return opportunity since it’s targeting small-caps. If you want something a bit less aggressive, stick with the iShares Core MSCI Emerging Markets ETF (IEMG) or the WisdomTree Emerging Markets High Dividend ETF (DEM).

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