Emerging market stocks are on a roll, but their most recent streak has come after a long, rocky ride – volatility that market watchers say could soon return.
The MSCI Emerging Markets Index has finished positive in seven of the last 10 sessions, including five consecutive closes in the black. The gains coincided with an uptick in commodities prices and news of growth abroad.
Although industry experts are largely positive about emerging markets in the long term, some caution investors not to grow too comfortable with the latest gains. In the near-term, if more countries come forward with deep economic problems, such as the debt situations that have rocked Greece and Hungary, investors could look to scale back their risk, creating short-term weakness in emerging markets, says Chad Deakins, portfolio manager of the RidgeWorth International Equity Fund.
Emerging markets have already been pressured this year. As of Friday’s close, the iShares MSCI Emerging Market Index fund (EEM) was off by 6.6% for the year, compared with a 2.1% decline in the S&P 500 index. Vanguard’s Emerging Markets Stock ETF (VWO) was down 5.1% for the year.
Yet investors have continued to place bets on developing economies. Emerging market funds have managed to attract more than $2.5 billion in new money in each of the first four months of the year, except February ($1.3 billion), for a total of $9.6 billion, according to the Investment Company Institute. By comparison, emerging markets netted just $2.0 billion during the first four months of 2008, and $1.2 billion during the first four months of 2009.
Emerging markets are continuing to draw attention because they make up a larger part of global gross domestic product than other countries relative to their market cap, says Deakins. Investors are betting that in time there will be “an equilibrium,” meaning these countries will realize their production growth in market cap, he says.
Bill Rocco, senior analyst at Morningstar, says investors should be looking out between 10 to 30 years in emerging markets – not short term – and should expect significant ups and downs along the way. Attempting to capitalize on a short-term bottom or peak is “asking for trouble,” as is betting on individual countries, he adds.
Deakins also warns that a near-term view in emerging markets could cause investors stress, but he adds, “in 12 months to 10 years, it’s an attractive place.”
Rocco suggests that investors interested emerging markets should first consider how much exposure they have and then “be serious about their risk tolerance.” Because most foreign funds will have about 10% of their assets in emerging markets and because some domestic funds also have exposure, investors may already have more of a stake in the space than they realize, he says.
The four so-called BRIC nations – Brazil, Russia, India and China – are often grouped together as the top emerging or growth markets, and may be strengthening their own ties to each other. However, each nation presents a different investment thesis.
Early interest rate hikes have worried investors, says Joel Wells, associate portfolio manager of the Alpine Mutual Funds. “But frankly, the economy is going so strongly in Brazil, especially in housing, that we don’t see it being an issue,” he says, adding that credit growth is “solid.” Brazil’s GDP increased 9% in the first quarter over the year-earlier period, the Brazilian Census Bureau, or IBGE, said last week. Such growth has led to some expectations for further rate hikes. Investors will be watching the elections in October, but any significant change of course is unlikely, as the country prepares for the World Cup in 2014 and the Olympics in 2016, Wells says. Infrastructure is lacking, and crime and safety remain problems, but the government has shown commitment to change, he says.
Russia is preparing for its own winter Olympics in 2014. The bullish case: Oil prices have stabilized; real estate is showing hints of life; and credit is “finally starting to come back, albeit slowly,” as some of the state-owned banks are very cautiously providing credit, says Wells. MSCI’s Emerging Market Eastern Europe Index (including Russia), is down 10.5% year to date, compared with a 15.4% decline in the index when Russia is factored out. The ING Russia A fund (LETRX), a single-country emerging markets fund, is down 3% for 2010.
The Indian economy has performed well since the 2009 elections. Like Brazil, the nation is at the forefront of pushing rates higher, says Wells. “They’re a step or two ahead [of other emerging markets] in the tightening cycle,” he says, and the country has a backlog of initial public offerings. Stocks themselves haven’t performed particularly well, but “long term from a supply and demand dynamic, it’s going to be fine,” he says.
Structurally, emerging markets are “clear winners” long term, but China is clearly tapping the brakes, Wells says. The repercussions are likely to reach more developed nations and are still unfolding, he says. Wells is cautious, but has a positive long-term outlook and adds that there are opportunities in China itself because a lot of companies “have been unfairly penalized in an environment where fear is guiding it more than fundamentals.”
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