Hot Take: It’s Time To Buy Emerging Market Stocks — And Our Top Considerations
Emerging market stocks has had new enemies following the decline in the MSCI Emerging Markets Index, which fell 20%. However, it is very likely that this decline has neared its end.
If you’re one of those people that have been putting off the idea of purchasing U.S. stocks, as a result of correction which has been projected to happen soon, then you should explore the opportunities in emerging markets (EM).
They have already undergone their correction. Therefore, they are not so expensive at the moment. Also, a catalyst ahead, lies just around the corner, mainly in the form of a decline in fears about a trade war, which will weaken the dollar, and consequently make emerging market stocks to rise.
The correction: Just a week ago, the MSCI Emerging Markets Index dipped about 20% from its notable high point which it sat towards the end of January, and compared with about a 1% fall in the S&P 500 Index SPX, -1.63% That’s reduced emerging market stocks to their 10-year average valuation, a nice discount to where they were in January when the dumb-money crowd was piling in.
Once again, many people dislike emerging markets, so this is the best time to buy in. Due to the following reasons, emerging market stocks will rise, and also, you can get exposure by the seven ways that follow.
1. The dollar will weaken
Owed to recent issues in Turkey, developing-country risk has been projected to the headlines, and a major part of the decline in emerging market stocks kicked in as soon as the dollar began to rise in April.
This idea holds water because a strong dollar negatively affects emerging markets in two ways.
- Many emerging market companies put their commodities up for sale, and strong dollar has a negative impact on the prices of the commodities.
- Several EM governments as well as private companies owe debts which are calculated in dollars. Therefore, weakening emerging market currencies raises concerns that it would be difficult to repay the debt.
However, the reverse is the case. The dollar is expected to fall, and consequently, this will cause emerging market stocks to rise again.
One may begin to think why the dollar is expected to weaken. The dollar became stronger because of the concerns and attention that trade wars stirred. However, the fears about trade-wars have reduced because President Donald Trump is aware of the consequences that may accompany it.
Though, a lot of talks about tariffs are still radiating from the White House. However, this is just a strategy to weaken foreign governments, and they seem to be having their way. Recent reports have shown that China is uninterested in the trade-war and have open their doors for talks on bilateral trade.
In the real sense, the U.S. economy will slack following a huge second quarter. And as we approach the midterm elections, President Trump is guarding against a further wreckage of the economy by the trade-war rhetoric. Therefore, he’s set to also negotiate.
James Paulsen, chief investment strategist at The Leuthold Group said that, every person is going to blame trade-wars, should the economy of the U.S. experience a dip. A lot of pressure would be put on Trump to resolve the situation. He added that a major part of this pressure would be put on him by his own party.
Charlie Wilson, co-portfolio manager at the Thornburg Developing World Fund expressed his optimism, and said that he was very positive that the trade would pull through.
2. The global economy will be fine
Many investors are fleeing emerging market economies for the U.S. “safe haven” because of fears about a slowdown in global growth. But this is mistaken. “Global growth is weak relative to last decade, but it is still chugging along,” says Wilson.
That will continue. Many central banks around the world are still easing, rather than tightening like the Fed, he notes. China has been lowering interbank lending rates and boosting infrastructure spending. Yields on 10-year bonds there have been falling, which encourages borrowing.
Next, emerging market economies are still in the early phases of their recoveries. Banks are looking healthier in Indonesia. The consumer is strong in India, where companies are posting better results as well, says Wilson. Most emerging market economies have younger populations than developed economies, which is good for growth.
“If the dollar comes off and the global economy stays in place, then I think you get a pretty healthy bounce in emerging markets,” says Paulsen.
3. Emerging markets are cheap
The MSCI Emerging Markets Index trades at 11 times forward earnings, and Wilson also noted that this number is consistent with its 10-year average. That may not seem interesting as a valuation. However, he added that there is a need to remember that the composition of this index is different in a way that means it should have a higher valuation as compared to what was formerly obtained.
Currently, several other tech companies such as Alibaba BABA, -3.03% Tencent TCEHY, -0.99% and Samsung Electronics SSNLF, -3.07% have become involved. Formerly, it had a bigger weighting toward basic -industry, mining and commodity-oriented companies, which is accompanied with lower variations than tech. Wilson noted the improvement in the quality of opportunities. He acknowledged the switch from heavy industry and commodity-driven growth to business models that are more valuable. Therefore, the tech industry has become a lot more valuable.
4. There will be no contagion from Turkey
The fall of emerging market currencies in 1997-98 caused an EM debt crisis which struck U.S. very hard. So, the concerns raised by Turkey is justifiable. However, it is very unlikely that it would happen again, J.P. Morgan economist David Hensley said. Trade with Turkey is relatively small. Banks beyond the bounds of Turkey are caught in loans of about $265 billion, with EU banks responsible for a huge part of them. However, European banks have the capacity to handle this.
Seven ways to get EM exposure
The Thornburg Developing World Fund THDIX, +0.66% which Wilson oversees is amongst the seven ways. With 86% of its assets invested in foreign countries other than the U.S., and according to Morningstar, it keeps growing, and owed to this, it outperforms competing funds by 1.7 percentage points in the previous year. Wilson also singles out these two companies that trade on U.S. exchanges as American depositary receipts (ADRs).
Azul AZUL, -2.34%: As indicated by the name (“blue” in Portuguese), this Brazilian airline was established by JetBlue Airways JBLU, -1.61% founder David Neeleman.
Azul is a regional airline in underserved markets that previously had no access to air travel. For this reason, it takes advantage of the poor infrastructure in Brazil. The airline conveys people to major hubs and air routes.
Till today, it lacks good competition, and this doesn’t look like it will change for a long time, and this is because the local markets Azul serves are not great. As a niche player, Azul has pricing power enough to make up for increases in the cost of fuel, or the hit to margins from the weakening Brazilian currency, says Wilson. (Some of Azul’s costs are in dollars.) As a consequence of upgrades to their fleet, they are making their fleets better. In addition to that, it will gain from shipping deals that goes down with the Brazilian post office and Amazon.com AMZN, -3.06%
ICICI Bank IBN, -1.32% : ICICI Bank is a play on the growth of consumer banking in India, as more people earn more. This translates to an increased purchase of financial products such as insurance, brokerage services and asset-management services. In recent times, India held back a huge amount of notes, causing lesser money to move around, which made it incredibly difficult to run big transactions in cash. As a result of this, more people needed banking products like savings accounts, checking accounts and mutual funds.
Wilson said that ICICI Bank is amongst the most reliable consumer and deposit franchises all over India. He added that the bank had great consumer-facing franchises, even if it wasn’t recognized for that, and the main reason for this is because they have a huge amount of bad loans. However, it has taken gradual steps in making things right, and Wilson thinks that this is very achievable due to its earnings power.
Investors are confused, and for that reason, the bank trades for about one times book value, if you minus the value of the shares of publicly traded subsidiaries it carries on its balance sheet. Normally, retail banks trade for two or three times book value, and for this reason, Wilson believes in the ability of ICICI Bank to do better.
You should also give a though to the four largest exchange traded funds (ETFs) around and leverage on them for emerging market exposure. Vanguard FTSE Emerging Markets ETF VWO, -1.87% iShares Core MSCI Emerging Markets ETF IEMG, -1.82% iShares MSCI Emerging Markets ETF EEM, -1.83% and Schwab Emerging Markets Equity ETF SCHE, -1.61%
Is this the correct time to invest in Turkey? Probably not. As a culture, the government has chased away high-growth, simulative policies. That amounted in growth. However, it was accompanied with inflation, which consequently took a toll and cause their currency to fall and this sparked the present crisis.
As a solution, Turkey may just need to give up growth, and leverage on their high interest rates, as well as government spending cuts to curb inflation. How will that work out? Wilson said that the inflation is not so difficult to manage, but it would continue to be so far as the government has not actually focused on curbing it. They haven’t acted rightly, and their actions are not consistent with the present needs of the market.
That means more weakness for the Turkish lira and the iShares MSCI Turkey Investable Market Index Fund TUR, -0.73% ahead. Wilson said that a simple story to learn from was the Greek crisis, and he recounted how terrible the situation got because it wasn’t handled properly.
