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Chinese stocks are sliding. Tariff barriers are rising. A populist politician – gasp! – has been elected to lead Mexico.

So what should an investor do at this perilous time? Buy emerging markets, of course.

To be sure, this isn’t a bet for everyone. But if you can tolerate risk and are thinking longer term, an investment in a broadly diversified basket of emerging-market stocks makes sense right now.

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One reason to like the developing world is that many of these economies – especially commodity producers such as Brazil and Russia – are not as highly exposed to trade wars as places such as China or South Korea. Another reason is that emerging markets are considerably cheaper than their U.S. and Canadian equivalents.

They’re also cheaper, as a group, than they were just a few months back. The iShares MSCI Emerging Markets Index ETF (XEM) and the Vanguard FTSE Emerging Markets All Cap Index ETF (VEE) are both down 12 per cent from their peaks in mid-March.

Conventional wisdom says more pain is in store, and that could well be true over the next few months.

The United States and China are expected to start slapping tariffs on many of each other’s goods beginning Friday. The tit-for-tat actions could spiral into a full-blown trade conflict and ravage the supply chains that link factories in Asia to consumers in the United States. Even if that doesn’t happen, rising U.S. interest rates are expected to draw capital back to the United States and drive the U.S. dollar higher, putting pressure on emerging markets lenders that have borrowed in greenbacks.

But before yielding to the pervasive pessimism, it’s worth pointing out how many smart investors still see opportunities in the developing world.

One of the most articulate proponents is Jeremy Grantham of GMO LLC, a money manager in Boston that oversees US$71-billion. Mr. Grantham argues that emerging-market stocks are an investor’s last refuge in an overvalued world. While returns on those assets aren’t going to be exciting – think 4.5 per cent a year, after inflation, over the next five years – they’re likely to beat Canadian, U.S. and European stocks, he says.

Emerging markets also draw applause from Rob Arnott of Research Affiliates LLC in Newport Beach, Calif. His company, a prominent name in quantitative investing, published a report last month that argued major emerging-market countries are in better shape than generally perceived.

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None of the most important emerging economies – China, South Korea, Taiwan, India and Russia – present any significant risk of being unable to fund themselves, according to Research Affiliates. Yet emerging-market stocks look cheaper than their developed-world counterparts on just about every available measure. “Now, when fear reigns supreme, it’s time to buy, not sell,” the report concludes.

AQR Capital Management, another noted quantitative researcher, also thinks well of the developing world. Its most recent forecast of returns for various stock markets puts emerging markets near the top of the heap. It foresees annual real returns of about 4.7 per cent a year for those markets over the next five to 10 years. That is higher than the projected forecast for Canada (3.9 per cent) and the United States (4.0 per cent) although slightly lower than the estimates for Britain (5.2 per cent) and Australia (5.1 per cent).

These forecasts could be wrong, of course, especially if the world trading system collapses into a hodge-podge of one-off deals.

But many of the current worries seem overblown. For instance, a stronger U.S. dollar may hurt emerging markets in various ways, but cheaper currencies in developing nations would also make these countries’ exports that much more competitive.

For that matter, some emerging markets are well positioned to ride the current trade storms. While China and South Korea, with all their export-oriented factories, have been smacked hard over the past couple of months, stocks in commodity producers like Brazil and Russia have risen since mid-June.

The ride from here is likely to be bumpy. But for patient investors, there is little reason to bail out of emerging-market stocks, and some excellent reasons to take advantage of the current weakness and buy more.

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Seven-year real return forecasts

Expected annual real return over seven years,

according to money management firm GMO

STOCKS

4

2

0

-2

-4

-6

U.S.

large

U.S.

small

U.S.

high

quality

Int’l

large

Int’l

small

Emerging

markets

THE GLOBE AND MAIL, SOURCE: gmo

Seven-year real return forecasts

Expected annual real return over seven years,

according to money management firm GMO

STOCKS

4

2

0

-2

-4

-6

U.S.

large

U.S.

small

U.S.

high

quality

Int’l

large

Int’l

small

Emerging

markets

THE GLOBE AND MAIL, SOURCE: gmo

Seven-year real return forecasts

Expected annual real return over seven years, according to money management firm GMO

STOCKS

4%

2

0

-2

-4

-6

U.S.

large

U.S.

small

U.S.

high

quality

International

large

International

small

Emerging

markets

THE GLOBE AND MAIL, SOURCE: gmo

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