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.