Emerging market (EM) ETF investing was in a tight spot last year. iShares MSCI Emerging Markets ETF (EEM Quick QuoteEEM - Free Report) has lost 11.6% past year (as of Jan 25, 2023) versus a 7.7% decline in the S&P 500. The dollar strength, rising rates in the United States, capital outflows, a slump in China’s economy, strong inflation and a debacle in Russia investing have all added up to the EM crisis.

The Fed hiked rates fast last year, which actually caused recessionary fears. The U.S. dollar has been strong with the greenback ETF Invesco DB US Dollar Index Bullish ETF (UUP Quick QuoteUUP - Free Report) adding 5.9% past. The U.S. dollar index rose to fresh two-decade highs and most emerging economies’ currencies have been falling to multi-year lows against the greenback.

However, EM investing has been gaining prominence to start 2023. Stocks in emerging markets are set to be this decade’s winners, Morgan Stanley Investment Management said, per Bloomberg, as quoted on Yahoo Finance. Developing-market bond and equity funds had inflows of $12.7 billion in the week through Jan. 18, the largest addition on record, while U.S. equities had $5.8 billion in outflows, according to a note from Bank of America Corp. citing EPFR Global data, Yahoo Finance quoted.

Why Emerging Markets Are Good Bets

Undervaluation

First, EMs have suffered a lot amid the pandemic. VWO has a P/E of 7.00X while SPY has a P/E of 21.70X. Hence, in the global market relief rally, emerging markets have better potential to grow. The asset class is off to great start to 2023 as the MSCI emerging-markets index jumped 8.6% compared with a 4.7% advance for the key U.S. equity gauge. Emerging-markets are trading at a nearly 30% discount to the U.S. stocks.

Falling Inflation in EMs

Developing nations from India to Brazil are reporting declines in consumer-price growth. Annual consumer price inflation in India unexpectedly eased to 5.72% in December of 2022 from 5.88% in November. It marked the lowest reading since December of 2021, also represented the second successive months when the inflation stayed below the Reserve Bank of India target range of 2-6%. Brazil and South Africa have also joined the peak-inflation group. This has lessened the need for rate hikes in some of the biggest EM economies.

Higher Growth Estimates

Emerging economies on average are expected to grow 4.1% in 2023 and 4.4% in 2024, according to estimates on Bloomberg. That’s way higher than the estimates for the United States, at 0.5% and 1.2%, respectively.

Bets on U.S. Rate Hike Falling; Lower U.S. Dollar Likely

From the United States to Europe, bets on rate hikes are now falling. The Fed rate will likely peak at 5.25%, with a chance of easing to 5% by the end of this year as U.S. inflation cools, Governor of Bank Indonesia Warjiyo told Bloomberg. The outlook on the Fed’s terminal rate is “much more certain now” compared to last year. The Fed also indicated to go slow on the rate hike font. This, in turn, should keep the greenback strength under control.

Against this backdrop, below we highlight a few emerging market ETFs that may gain strength ahead. These ETFs have been decent performers in the one-year and year-to-date timeframe.

ETFs in Focus

J.P. Morgan Diversified Return Emerging Markets Equity ETF (JPEM Quick QuoteJPEM - Free Report) – Up 6.5% YTD; Down 2.6% past year

ALPS Emerging Sector Dividend Dogs ETF (EDOG Quick QuoteEDOG - Free Report) – Up 7.4% YTD; Down 2.7% past year

Invesco RAFI Strategic Emerging Markets ETF – Up 12.70% YTD; Down 4.40% past year

WisdomTree Emerging Markets High Dividend Fund DEM – Up 9.48% YTD; Down 4.63% past year

Columbia Emerging Markets Consumer ETF (ECON Quick QuoteECON - Free Report) – Up 10.40% YTD; Down 5.22% past year