Tony Daltorio: Emerging markets are re-emerging onto investors’ radar screens.
Flows into emerging-market funds globally in early March were at the highest levels since the end of 2013. That happened as a rebound in appetite for risk assets returned amid a period of relative stability in all financial markets. The rebound in risk appetite brought the MSCI Emerging Market Index to about the flat line for 2016.
Doubts persist though. Many investors question whether this rebound is for real, or whether this is just a sharp rebound in a continuing bear market in emerging-market stocks.
Emerging-Market Stocks Are Very Cheap
EM stocks have certainly lagged. Last year was particularly brutal, with the benchmark MSCI Emerging Markets Index down nearly 15%.
MSCI Emerging Markets Index
Source: Fast FT
Overall, the EM index has underperformed developed market equities by more than 50% over the past five years in U.S. dollar terms. That has dampened investor sentiment. Paul O’Connor of Henderson Global Investors told the Financial Times, “Investor sentiment and positioning paint a picture of widespread investor capitulation in emerging markets, offering some encouragement from a contrarian perspective.”
As a card-carrying contrarian, I agree. Most investors run out of the room screaming when you mention emerging markets.
That screaming is music to my ears. To me, it means emerging markets have seen the investor capitulation that the U.S. markets are still far from.
And EM valuations are dirt cheap. Valuations in many cases are at levels not seen since the 1997-1998 Asian financial crisis.
Emerging-market stocks on average trade at 1.4 times book value. That is a 28% discount to their average over the past 10 years. In contrast, developed-market stocks trade on average at 2.8 times book value. That is a premium of 15% to their 10-year average.
In addition, the benchmark index trades at 28% discount to developed countries’ stocks when looking at forward price-earnings ratios compiled by Bloomberg. That translates to valuations having been cheaper only six times since the launch of the MSCI index.
But as I told readers in a previous article, very broad indexes are not the way to play emerging markets. Not all developing markets are created equal. You have to pick and choose.
Where to Nibble
Which countries are worth a look?
It’s easier to first eliminate the countries to avoid. These include Turkey, Poland and Hungary, where the governments are moving in an authoritarian direction. Also still steer wide of South Africa and Brazil. The governments there are corrupt and inept. Brazil will only get better when President Rousseff is finally gone.
Two countries in Latin America are worth a look: Argentina and Mexico. Argentina’s new president, Mauricio Macri, is a breath of fresh air after years of socialism. And Mexico is quickly becoming an industrial (particularly auto) powerhouse.
Investors should consider two ETFs – the Global X MSCI Argentina ETF (NYSEArca:ARGT) and theiShares MSCI Mexico Capped ETF (NYSE: EWW).
In Asia, several countries are worth investing into. These include China, India, Indonesia and the Philippines.
Investors can invest into the Philippines via the iShares MSCI Philippines ETF (NYSEArca: EPHE).
With China undergoing its economic transformation, investors need to avoid the old industrial sectors and stick with the services and new economy sectors. Two ETFs that own mainly new economy stocks are the KraneShares CSI China Internet ETF (NASDAQ: KWEB) and the Market Vectors ChinaAMC SME-ChiNext ETF (NYSEArca: CNXT). But keep in mind, both are highly volatile.