We are closing the books on a remarkable six-year cycle for stocks, bonds and the global economy. You can break this cycle down into four distinct phases:

• In early 2008, global economies began to show some cracks, especially in the all-important U.S. housing sector, yet concerns of global overheating were still evident, as seen by the “super-spike” in crude oil to more than $140 a barrel in June 2008. That surge may have been the tipping point that pushed many economies to the breaking point, and by year’s end, the global economy was in freefall. 

• In 2009, unemployment surged, a slew of European economies appeared to be on the cusp of collapse, and government policy makers were scrambling to avoid a truly catastrophic global economic meltdown.

• In 2010 and 2011, business conditions began to improve, most notably in the U.S. And China’s economic resilience helped many Asian neighbors buck the global malaise. 

• In 2012 and 2013, investors finally realized that further global crises wouldn’t derail an impressive market rally in the U.S. (and eventually Europe), and as we wind down this six-year cycle, economists are calling for calmer days ahead in 2014, led by a slow strengthening in the U.S. and Europe.

Now, against that backdrop, check out how stock markets have fared over those six years. According to S&P Capital IQ, the S&P 500 Index has delivered a 37.5% total return; other developed markets (such as Europe,  Japan, Australia, Japan, etc.) have risen just 2.6%, while emerging markets are now 5.3% below levels seen back at the end of 2007.

Going into this year, both Europe and Japan were the global laggards, but gains of 18%, and 24%, respectively, since January 2008 have pushed Europe and Japan ahead of emerging markets on a six-year basis. The biggest loser in 2013: emerging markets in Latin America, which have slumped 13%. Blame goes to a drop in commodity demand from China and a general slowing in Brazil, the region’s largest economy.

Still, emerging markets have delivered the world’s best economic growth rates over the past six years, and in 2010 and 2011, that became a key theme for globally bullish investors. Since then, despite continued superior growth, these economies (and markets) have been seen as too risky in the face of rising inflation trends and more wobbles by the Chinese economic juggernaut. That explains the hundreds of billions of dollars flowing out of emerging markets and into developed markets over the past two years.

Looking Ahead To 2014
Even with the challenges associated with lower commodity prices and inflation triggered by infrastructure bottlenecks that is leading many emerging-market central bankers to raise interest rates, emerging-market growth will still lead the pack in terms of GDP gains. According to a Bloomberg poll of economists: 

We are closing the books on a remarkable six-year cycle for stocks, bonds and the global economy. You can break this cycle down into four distinct phases:#-ad_banner-#​

• In early 2008, global economies began to show some cracks, especially in the all-important U.S. housing sector, yet concerns of global overheating were still evident, as seen by the “super-spike” in crude oil to more than $140 a barrel in June 2008. That surge may have been the tipping point that pushed many economies to the breaking point, and by year’s end, the global economy was in freefall. 

• In 2009, unemployment surged, a slew of European economies appeared to be on the cusp of collapse, and government policy makers were scrambling to avoid a truly catastrophic global economic meltdown.

• In 2010 and 2011, business conditions began to improve, most notably in the U.S. And China’s economic resilience helped many Asian neighbors buck the global malaise. 

• In 2012 and 2013, investors finally realized that further global crises wouldn’t derail an impressive market rally in the U.S. (and eventually Europe), and as we wind down this six-year cycle, economists are calling for calmer days ahead in 2014, led by a slow strengthening in the U.S. and Europe.

Now, against that backdrop, check out how stock markets have fared over those six years. According to S&P Capital IQ, the S&P 500 Index has delivered a 37.5% total return; other developed markets (such as Europe,  Japan, Australia, Japan, etc.) have risen just 2.6%, while emerging markets are now 5.3% below levels seen back at the end of 2007.

Going into this year, both Europe and Japan were the global laggards, but gains of 18%, and 24%, respectively, since January 2008 have pushed Europe and Japan ahead of emerging markets on a six-year basis. The biggest loser in 2013: emerging markets in Latin America, which have slumped 13%. Blame goes to a drop in commodity demand from China and a general slowing in Brazil, the region’s largest economy.

Still, emerging markets have delivered the world’s best economic growth rates over the past six years, and in 2010 and 2011, that became a key theme for globally bullish investors. Since then, despite continued superior growth, these economies (and markets) have been seen as too risky in the face of rising inflation trends and more wobbles by the Chinese economic juggernaut. That explains the hundreds of billions of dollars flowing out of emerging markets and into developed markets over the past two years.

Looking Ahead To 2014
Even with the challenges associated with lower commodity prices and inflation triggered by infrastructure bottlenecks that is leading many emerging-market central bankers to raise interest rates, emerging-market growth will still lead the pack in terms of GDP gains. According to a Bloomberg poll of economists:

• — The Chinese economy grew 7.8% in the third quarter, up from 7.5% in the second quarter, and is expected to grow 7.4% in 2014, which will have beneficial effects for all of its trading partners.

 

• — Goldman Sachs estimates emerging-market economies grew 5.2% this year and will grow 5.3% in 2014, with growth picking up to 5.8% in 2015.

 

• — Specific countries will do better. Indonesia, for example, is expected to grow nearly 6%, and in countries such as Turkey and Mexico, GDP growth is expected to re-accelerate to around 4% in 2014.

 

• — Meanwhile, the eurozone economies are expected grow around 1%, while U.S. growth is currently expected to be in the 2.5% range. 

Despite solid growth forecasts, global investors are still ignoring the fact that emerging markets carry lower valuations. Goldman Sachs estimates that aggregated emerging markets are valued at around 10 to 11 times 2013 earnings, well below the S&P 500’s multiple of 15.

Of course relative economic growth rates and valuations haven’t mattered to investors in the past few years. Instead, investors have been comforted by the huge and unprecedented stimulus programs put in place by the Federal Reserve and the European Central Bank.

Fears of the global impact of the Fed’s tapering could actually continue to hurt emerging markets in 2014 as well. Investors don’t like unpredictability, and we won’t know how global markets will fare if the U.S. economy shows negative effects from the Fed’s wind-down of quantitative easing (QE). The current consensus anticipates the current $80 billion monthly bond buying program will start to be reduced at March’s Federal Open Market Committee meeting by around $15 billion per month, with a full end to the program by September 2014.

Will emerging-market investors need to wait that long to be assured that the end of QE won’t deal another blow to these fragile markets? I don’t think so. The recent impressive jobs report, which could have spooked markets for fear of a quicker-than-expected Fed tapering, was actually greeted with joy, as the markets raced ahead. Then again, the market action since then looks a lot like profit-taking.

Right now, the market is slowly adjusting to the reality of the end of Fed easing, which actually may prove to be a strong positive for emerging markets in 2014. A renewed focus on economic growth fundamentals and what are now massive valuation gaps between emerging markets and developed markets could be the theme of 2014, once QE has come to an end and the global economy has survived intact.

After The Taper
This won’t be a rapid shift. If the recent U.S. market weakness continues, emerging markets will be hard-pressed to rally. Instead, wait for U.S. markets to eventually stabilize. At that point, the relative appeal of emerging markets is going to come into sharper focus.

Over the next month, I will be profiling my favorite emerging markets for the year ahead. I’ll also be focusing on the emerging markets you should avoid, no matter how tempting their valuations may be. For now, I’ll leave you with a few thoughts.

• Chile’s copper-heavy economy has surely felt the China impact, but Chilean growth is becoming decoupled from foreign trade as the country’s domestic consumption keeps rising at a solid pace. The iShares MSCI Chile Capped ETF (NYSE: ECH) has lagged behind the S&P 500 by 50 percentage points over the past year, even though most of this exchange-traded fund is focused on domestic consumption stocks, and not mining or industrial stocks.

• Indonesian stocks are also getting hammered this year, sporting some of the same performance gaps as Chilean stocks (compared with the U.S.), despite the fact that Indonesia’s economic growth rates are among the highest in the world. The iShares MSCI Indonesia ETF (NYSE: EIDO) is among this year’s worst-performing country-specific ETFs, even though more than 60% of its assets are in fast-growing consumer-focused companies. A notable concern: Indonesia runs a trade deficit, which is one of my key inputs to use when looking at emerging markets. 

Risks to Consider: As noted, emerging markets probably won’t rally until it’s clear that U.S. markets are stabilizing as the Fed backs off. 

Action to Take –> Many investors have come to think of emerging markets as simply being too risky. Yet it’s when global investors shun them that these markets are best positioned for eventual outperformance.

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