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All Contents © 2019The Kiplinger Washington Editors
By Charles Lewis Sizemore, CFA, Contributing Writer
| January 10, 2018
There are bull markets and bear markets… and then there are emerging markets.
While the United States has been the engine that makes the world economy go for nearly a century now, it’s also a mature economy. We’re happy to see GDP growth in the 3% to 4% range. Yet in many EMs, GDP growth rates of 8% to 10% are fairly common. At those rates, the size of the economy doubles every seven to nine years. So, you’d expect emerging-market stocks to be perennial outperformers.
That’s not always the case. The iShares MSCI Emerging Markets ETF (EEM) – the most popular and easily accessible vehicle for trading a basket of emerging-market stocks – soared from just $11 per share in April 2003 to nearly $56 per share in October 2007. That means investors in a broad, boring EM fund made five times their money in a little over four years.
Alas, it didn’t last. EEM dropped below $20 per share in the 2008 meltdown, losing about 65% of its value. U.S. stocks took a similar beating too, of course, but America quickly rallied and recouped its losses, while EM stocks remained in a rut for the better part of the following decade.
Why? Well, it’s complicated. For instance, slower growth in the U.S. and Europe meant less demand for manufactured products from East Asia, which in turn meant less demand for commodities from Africa, Latin America and Southeast Asia. And a surge in crude oil production from American frackers caused energy prices to sag, which sapped growth in Russia, the Middle East and other oil-exporting countries.
However, after finding a decisive bottom in 2016 and rousing to life in 2017, emerging-market stocks appear ready to shine again. Today, we’re going to look at five emerging markets that look particularly promising in 2018.
I’ll start with a country that, if it plays its cards right, stands to be the next great economic power in the coming decades: India.
India is massive country of 1.35 billion people with a young workforce and widespread English proficiency. It also has a common-law legal system, a long tradition of literacy and numeracy and is strategically located between East Asia and Europe. Among emerging markets, India is by far the best-positioned to prosper in a services and information-based economy.
Already, the economy is expanding at a torrid pace. GDP growth came in at 6.3% last quarter and has been climbing at a blistering rate for years.
However, this also is a country that is overcrowded, has a major poverty problem and has woefully inadequate roads and basic infrastructure. For crying out loud, as recently as a few years ago, more than half the country lacked access to a toilet.
So, it’s important to have realistic expectations. India has a Reaganesque, reform-minded leader in Narendra Modi, and the groundwork being laid today will lead to economic growth tomorrow. But let’s face it; there’s still a lot of work to be done.
In the meantime, Indian stocks are showing serious signs of life. Market technician J.C. Parets, founder of Eagle Bay Capital and the popular technical analysis blog All Star Charts, noted in late December that Indian stocks were breaking out of a seven-year base. As Parets writes, “We want to be buyers of any weakness in India.”
For exposure to India, Parets suggests the iShares India 50 ETF (INDY).
Multiple Brazilian friends joke with me privately that “Brazil is the country of the future … and it always will be!” The takeaway, of course, is that Brazil is a chronic underachiever that never quite seems to live up to its potential.
That criticism isn’t completely without merit. Brazil’s history has been one of inflation, corruption and instability. The country recently impeached one of its presidents, Dilma Rousseff, for corruption. Her predecessor, Luiz Inacio Lula da Silva, is also currently appealing a prison sentence for corruption, and her successor, Michel Temer, is embroiled in an ongoing corruption scandal of his own.
Nevertheless, Brazil is a commodities powerhouse. It’s the world leader in coffee, sugar and many other “soft” commodities, and it is a major producer of industrial metals as well. This has arguably been more of a curse than a blessing over the past decade amid weak prices. However, as the 2008 crisis and Great Recession becomes more and more of a distant memory, we’re likely to see at least a modest uptick in inflation over the next decade, which should bode well for commodities prices. And if you believe commodities are likely to trend higher, it makes sense to allocate a piece of your portfolio to Brazil.
Brazil also is more than the world’s breadbasket. The country has a well-developed industrial sector and is competitive in aircraft and auto manufacturing.
The most liquid way to get access to the Brazilian market is via the iShares MSCI Brazil Capped ETF (EWZ). As you might expect, it counts mining giant Vale SA (VALE) among its largest holdings. But fully 37% of the ETF’s market cap consists of financial services, with another 16% allocated to consumer staples.
It’s unfortunate, but Colombia tends to stir some rather unsettling mental images to a lot of American investors who remember the drug-related violence of the 1980s and early ‘90s. And if it wasn’t cocaine barons, it would be guerilla and paramilitary groups, which have terrorized large swaths of the country for five decades.
Thankfully, Colombia’s history of violence and instability is mostly in the past, and the country has been one of the developing world’s true shining stars in recent years. Today, Colombia is the fourth-largest economy in Latin America after Brazil, Mexico and Argentina, and is politically stable. Just this year, its five-decade conflict with the guerilla group FARC finally came to end when the group agreed to disarm and become a legal political party.
Decades of low-level civil war set back Colombia’s development, but the country is catching up quickly. Although growth has been somewhat modest over the past three years, the country has regularly posted GDP growth of 6%-8% over the past two decades.
If you want access to what should be one of the fastest-growing Latin American economies over the next decade, consider Global X MSCI Colombia ETF (GXG). But a fair bit of warning is needed here. The Colombian markets are not as deep and liquid as those of, say, India or Brazil. The country is mature enough to be considered an “emerging market” rather than a “frontier market,” but its economy and financial markets still are at much earlier levels of development.
For a more contrarian play, consider Mexico.
Mexico’s manufacturing sector has been a major beneficiary of the North American Free Trade Agreement, and Mexico’s world-renown beach resorts bring billions of tourist dollars to the Mexican economy. But all of that was looking suddenly at risk by late 2016 and particularly after Donald Trump’s surprise election win. After all, this was an incoming president that promised to build a border wall and renegotiate the NAFTA agreement to narrow the trade deficit.
Meanwhile, gangland violence in the north of the country in recent years has disrupted trade and discouraged tourists and business visitors. The sagging oil price and years of lousy management also undermined Mexico’s cash-cow energy industry, and intense competition from East Asia has been slowly undercutting Mexican manufacturing for years. Mexican GDP growth has been declining for four consecutive quarters, and in the third quarter it actually fell into negative territory, dropping 0.3%.
If all of that wasn’t enough, Mexico has a presidential election in 2018 that promises to be a doozy. The ruling party is widely unpopular, and the leading candidate is Andrés Manuel López Obrador, a leftist populist and perennial troublemaker.
But at some point, you finally hit bottom, and it’s likely that Mexico is close. With the Fed likely to keep raising rates in 2018, the dollar should strengthen, which makes Mexican exports more competitive and raises the purchasing power of Mexican consumers who receive remittances from relatives working in the United States. Furthermore, Mexico’s government is notoriously gridlocked, so even if Lopez manages to win, he won’t have the power to make a mess the way that, say, the late Hugo Chavez did in Venezuela. The most likely outcome is that Mexico returns to respectable, if somewhat modest, growth.
If you believe the worst is already largely priced into the Mexican stock market, consider the iShares MSCI Mexico Capped ETF (EWW).
No story on emerging markets is complete without a mention of China. After all, China is the proverbial 800-pound gorilla. Its unquenchable thirst for raw materials is a major driver of growth in other emerging markets, particularly those in Southeast Asia, Africa and Latin America. So as goes China, so goes the rest of the developing world.
According to Mario Randholm, founder of Randholm & Co., a quantitative money manager with clients in Europe and South America, “China embarked on a global shopping spree (in 2016), sending emerging-market mergers and acquisitions to record levels. In 2017, M&A activity has continued to be strong, though more in line with the average of the past decade.”
It’s hard to get reliable data out of China, as official statistics are generally mistrusted. But Chinese construction figures suggest significant growth ahead.
Randholm continues, “The latest peak in new housing starts was in the second quarter of 2016. It usually takes 18-24 months for a corresponding peak in completions. Some of the heaviest use of copper and other metals happens in the later stages of construction. So, expect Chinese demand to be particularly strong throughout the first half of 2018.”
In other words, China’s building boom is far from over, which should mean continued strong growth.
Regardless of what happens in China’s economy, there are reasons to believe Chinese stocks are poised to do well. MSCI announced in June that it would start including Chinese A shares (stocks of mainland Chinese companies) in its benchmark emerging market indices in 2018. An estimated $1.6 trillion in assets is currently allocated to MSCI emerging market indices, so a flood of new money should pour into Chinese stocks in the years ahead.
For direct exposure to Chinese mainland shares, you can consider the Deutsche X-Trackers Harvest CSI 300 A-Shares ETF (ASHR).
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