Saturday, August 3, 2013
Investors would be making a big mistake if they eliminate holdings in emerging market stocks. Instead of giving up on emerging markets investors should adjust to take advantage of China’s new economic focus on consumer spending rather than infrastructure.
Many articles have declared the “end of emerging markets” .Massive outflows from emerging markets funds and ETFs indicate that in fact many investors agree. Moving out of emerging markets and into the US market is a common case of chasing performance ytd emerging markets (VWO) are down 9.3% vs. a 20.9% gain for the US (VTI )
Chasing performance is seldom a strategy for good long term returns. With emerging markets at low relative valuations to the US it is more likely to be an opportunity long term investor to buy stocks at good valuation “when blood is on the streets” rather than follow the herd that is selling.
The main reason behind the emerging market slowdown is no doubt the “slowdown” in economic growth in China. Chinese economic policy has shifted from big spending on infrastructure projects to policies to stimulate consumer activity. The slower economic growth is now forecast at” only” 4-5% down from 7% or more. GDP growth at 7% is over 3x the current US growth rate.
What is the right way to invest in emerging markets in the period of China moving from consumption to infrastructure focus?
Investing in Emerging Markets for the New Era
1. Forget the BRIC (Brazil, India, and Russia China) strategy. The category BRICs (BIK, BKF) never made much sense from an investing point of view. Each country has its distinct economic and political issues. Investing in these countries as a group does not make sense.
2. Underweight Latin America for the long term. In my previous position in international finance a common refrain was that Brazil (EWZ) and Mexico (EWW) were the countries of the future…and always will be. They are characterized by poor economic and political management and dependence on exports of natural resources (copper for Brazil, oil for Mexico). Peru and Chile are also highly dependent on natural resource exports. With China slowing down infrastructure products a major importer of natural resources all of these countries in Latin America will lose their main export market.
3. Don’t miss out on South Korea. Two of the major broad emerging markets ETFs (EEM and VWO) have switched their benchmark index as a consequence South Korea has moved from emerging to developed markets. Thus both EEM and VWO have a no holdings in South Korea that. For broad emerging markets exposure the better case is IEMG which has a 15% allocation the South Korea and at 3% Samsung is the largest holding.
4. Tilt towards Emerging Asia. Asia has just the opposite profile of Latin American with little dependence on natural resource exports. Just as one could avoid Latin America because of its dependence on natural resource exports. The China and Emerging Asia growth story still exists with high growth relative to developed markets. A pickup in US consumer spending will help China and the other countries in Emerging Asia: Taiwan, Indonesia, Hong Kong and Malaysia.
Furthermore as China’s wage costs have risen some of these companies now have become the lowest cost producer from many exporters.
The emerging Asia ETF (GMF) covers all of these countries but has its highest country weighting in China.
For those seeking to underweight China they could purchase a mix of country funds: Taiwan (EWT), South Korea, (EWS), Malaysia (EWM) would be a few examples.
5. With Chinese economic policy shifting to stimulating consumer spending rather than infrastructure it makes sense to look at emerging market ETFs that are more weighted towards consumer stocks This is the case for EEMV the minimum volatility emerging markets in large caps and in small caps EWX
For those with access to the fund through their 401k or an advisor DEMSX may be an attractive alternative.
6. Two stocks worth investigating in light of the shift in Chinese economic policy that have ADRs that trade in US markets:
Baidu (BIDU) is the largest internet search provider in China the stock is volatile and has had a long run up of late but still merits a look.
China Mobile (CHL) the largest mobile phone service provider in the world’s largest cell phone market. It trades at a P/E of 11 well below the P/E of comparable US companies or the overall US market.