Important Changes In China
It’s difficult to write about emerging markets without specifically discussing China.
Investor sentiment has become bullish as investors are speculating on further monetary easing. There has been a concomitant increase in Chinese retail investor participation in the equity markets, and more than 10 million stock accounts have been opened since the beginning of December 2014 and the end of the first quarter of 2015.
That’s equivalent to the total number for 2012 and 2013 combined.
Emerging Market Currencies Vs. The Dollar: Potential Structural Changes
- BRICS Development Bank is expected to be fully functioning by the end of 2015, with reserves of approximately $100 billion. It will serve as a pool of money for infrastructure projects in Russia, Brazil, India, China and South Africa.
- The number of increases in Chinese bilateral swap agreements will facilitate trade in renminbi without the U.S. dollar medium.
- The newly formed, China-led, $50 billion Asian Infrastructure Investment Bank has been established with wide international support.
Opportunities In Asia?
To cut to the chase, one of the emerging market countries with relative strength is China, which can be accessed with solid funds such as the SPDR S&P China ETF (GXC | C-33) and the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | D-54). Also exhibiting strength are Hong Kong, Taiwan and South Korea, which are investable with the iShares MSCI Hong Kong ETF (EWH | B-100), the iShares MSCI Taiwan ETF (EWT | B-93) and the iShares MSCI South Korea Capped ETF (EWY | B-93).
India—a market well canvassed by the iShares MSCI India ETF (INDA | C-95) and the WisdomTree India Earnings Fund (EPI | C-81)—had substantial relative strength in 2014, and there is evidence of a strong secular growth trend.
However, recently, its relative strength faded, and valuations are cheaper than those of the U.S. and EAFE, but not as cheap as the rest of Asia.
China’s forward P/E was an attractive 12.62 as of April 30, 2015. Taiwan’s forward P/E is 13.33, and South Korea’s was cheap, at 10.78.
We believe those cheap valuations, along with strong growth in Asia in general, make them attractive. Investors looking to capture the region as a whole in one ETF should look at the iShares MSCI All Country Asia ex Japan (AAXJ | B-85), which would capture much of the region, including India.
Currency-Hedging EM Exposure
In our view, currency-hedged emerging markets exposure makes a lot of sense from a risk/return point of view—at least partially so—as currency volatility has been extreme recently.
As far as that goes, the Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF (DBEM | D-68) does fare well in our ranks. The fund captures emerging market exposure while hedging away the currency risk.
In our opinion, it makes sense to stick with the commodity consumers (China, India, Taiwan and Korea) and wait for trend confirmation with the producer countries such as Brazil, Russia and South Africa—each of which can be accessed through the following ETFs:
- iShares MSCI Brazil Capped ETF (EWZ | B-97)
- Market Vectors Russia ETF (RSX | B-74)
- iShares MSCI South Africa ETF (EZA | B-95)
The risks in the emerging markets are many, and include higher volatility in broader emerging markets without higher return. Additionally, the risk of a strong dollar causing a currency-funding crisis in Mexico, Brazil, South Africa and Turkey are real.
In China, many point to a credit bubble in housing. Our research indicates there is indeed a bubble in that sector, but we don’t believe it will affect long-term China growth rates to the point that its growth would be greatly slowed.
Further energy price weakness is, of course, a risk (and the current trend) in broader emerging markets. Since commodities are so strongly weighted in emerging market indexes, broader emerging market exposure is not a recommended overweight.
What To Watch For Now
We think it makes sense to watch the currencies of commodity-producer countries. When the long-term relative strength (versus the dollar) in commodity-producer country currencies improves, they may have less trouble financing their current accounts. Conversely, if their currencies remain weak, then they may be subject to currency crisis.
For now, it’s our opinion that investors should stick with the Asian growth economies; namely, China, Taiwan, South Korea and India, and hedge a portion of the currency where possible. That posture should remain in place until there’s confirmation that, with stronger emerging market currencies, a broad emerging market long-term relative trend has begun.
At the time of publishing, the author’s firm owned shares of AAXJ and GXC in client portfolios. Clark Capital Management Group is an independent investment advisory firm providing institutional-quality investment solutions to individual investors, corporations, foundations and retirement plans. Clark Capital was founded in 1986 and has been entrusted with approximately $3 billion in assets. For more information about Clark, contact Advisor Support at 800-766-2264 FREE or [email protected]. Please click here for a complete list of relevant disclosures and definitions.