Emerging Markets Might Be Prime Opportunity

Emerging markets have long been out of favor with investors who have watched funds such as the iShares MSCI Emerging Markets (EEM | B-100) and the Vanguard FTSE Emerging Markets (VWO | C-93) slide to multiyear lows in recent months.

That weakness has been largely tied to the downturn in commodities markets, led by oil, and on China’s struggle to foster growth—and investor confidence—alike. But in the past few weeks, there’s talk of a bottom in the segment.

Chart courtesy of StockCharts.com

So we asked three ETF strategists whether now is the time for investors to buy into emerging market ETFs, and if so, should they go broad, focus on BRICs or pick specific countries?

Here’s what they had to say:

Tyler Mordy, president/CIO: Forstrong, Toronto

Emerging markets are forming a bottom. The latest treatment of emerging markets is far removed from the red carpet on which they trod during China’s roaring bull years. But is it warranted? Not likely.

The consensus on China has spun a narrative that policy has finally pivoted to pursuing a weak renminbi, providing evidence of an imminent hard-landing scenario. While growth is slowing and should not be trivialized, the more important story is China’s solid progress on the road to rebalancing; namely, a shift away from manufacturing and construction activity toward consumers and services. This is exactly what well-intentioned Western economists urged emerging markets to do: rebalance economies away from cheap exports to a more self-sustaining middle class.

Secondly, forecasts of a widespread EM crisis are also off the mark. Here, the commentary has focused on slowing growth and high debt, with extravagant comparisons to the 1997-98 Asian crisis. Yes, exports are slowing. But this is concentrated in the commodity exporters, declining by almost 40% in July on year-on-year terms. And the outlook is actually improving for a number of countries.

It’s important to recognize that emerging markets already had a large slowdown between 2010 and 2012. Since then, currencies have weakened, boosting competitiveness; commodities have fallen, raising consumption; and policy has turned stimulative, lowering the cost of capital. These benefits always show up with a lag. Why should this time be different?

Finally, emerging market assets are marked down and deeply in the bargain bin. In the retail world, EM mutual fund outflows are at near-record levels. This was only matched in 2008 and 2011, and were followed by significant rallies.

In the institutional universe, fund managers are similarly sour. EM “underweight” positions are at a record net 34%, and “aggressive” underweights just hit an all-time high. Contrarians take note: EM positions should be raised to “overweight.” As the EM story transitions, favor domestic-focused, reform-minded, commodity-importing countries. Most of these are found in Asian nations—countries like India, the Philippines and, yes, China.

Conversely, those economies that have been complacent about a slowing of China’s rapid industrialization era are likely to continue faltering. Global investors should be positioned for significant country re-ratings. In emerging markets, country selection matters.

Dave Garff, president/CIO: Accuvest, Walnut Creek, Calif.

We are very interested in emerging markets and are slightly overweight in our global and international portfolios.

Specific countries are the way to go for sure. Right now, we like Korea, Taiwan, South Africa, Turkey, Hong Kong, China and Indonesia.

Most of Latin America, with the exception of Mexico, is near the bottom of the list, along with Malaysia and Singapore.

Clayton Fresk, portfolio manager: Stadion Money Management, Watkinsville, Georgia

Given the rough latter two-thirds of 2015 that emerging markets experienced both absolute and relative to other assets, I think it’s worth at least looking at a reallocation/reweighting from other asset classes such as developed markets.

The ratio of emerging versus developed (EAFE) performance has seen some sharp improvement since late January. That being said, there is some “buyer beware” as the ratio saw similar levels of relative improvement in late August through mid-October, only to reverse in the latter part of 2015.

In terms of where to grab emerging market exposure, on a regional basis, South/Central America has been leading the rally, while Asia has been lagging. But given we’re still in the early stages of what is yet to be determined to be a sustained rally, one may be better served using a broad EM allocation (such as the Vanguard FTSE Emerging Markets (VWO | C-93)) to capture exposure rather than attempting to time entry into a single country and/or region.

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Contact Cinthia Murphy at [email protected].