Thanks to the wild market swings of the past month, emerging-market stocks are trading at historic lows. That means investors have a rare opportunity to load up on stocks at valuations they wouldn't see under normal circumstances.
If we were talking about a sell-off that was based on fundamentals, that might be a warning sign. But what we've seen instead is the irrational dumping of companies that actually are poised to see their profits grow.
Take a look.
The stock-market sell-off that's pushed the Dow Jones Industrial Average down 9% in the past month has rubbed off on emerging-market stocks. The MSCI Emerging Markets Index, which tracks market performance in developing economies, has slipped 12% this month – its worst slide in three years. After falling as low as 990, it's now trading around 1,010, 28% below its 20-year average.
This puts emerging-market stocks near record-low valuations, and with their high-growth outlook it's time for investors to scoop them up at bargain prices.
"We've been pecking away at things as they decline," billionaire investor Wilbur Ross, chief executive officer of WL Ross & Co., told Bloomberg Television. There's "plenty that's attractive in the emerging markets. Buying stocks at today's prices over a couple of years' time period will prove to be a uniquely rewarding experience."
Current emerging-market valuations are at their lowest level since March 2009, but companies are worth much more than share prices reflect. The latest prices imply these companies will lose about 20% of earnings over the next year, according to Morgan Stanley (NYSE: MS), when in reality they're poised for growth.
A survey of Bloomberg analysts estimated emerging-market company earnings could increase about 19% over the next year.
"Stocks look like buys," Nicholas Smithie, emerging-market strategist at UBS AG (NYSE: UBS) told Bloomberg. "There has to be a Lehman-style collapse in economic activity and stress in the financial system for these valuations to be justified."
Citigroup Inc. (NYSE: C) analyst Jason Press agreed the recent market sell-off pushed stock prices down to misleading levels.
Stocks are "pricing in an earnings recession, which certainly does not seem to be the case," Press told Bloomberg.
While some developed nations may be headed for a double-dip recession, many emerging-market consumers will continue spending, keeping company earnings strong.
Developing-market earnings have far outpaced companies heavily reliant on debt-plagued United States and Europe for profit. Second-quarter profits at MSCI index companies were up 30%, more than five times profits for companies in the MSCI World Index, up only 5.6%. And the earnings-per-share for emerging-market companies were up to a record high of $95 last month.
That earnings disparity is set to grow going forward. Emerging economies are expected to expand 6.4% next year, compared to only 2.6% in advanced nations, according to International Monetary Fund (IMF) estimates.
The past couple of times promising emerging-market stocks have fallen steeply, they've rallied big for investors.
The MSCI Index is currently trading around 9.8-times earnings, and the last time the measure hit 9-times earnings – in October 2008 – investors enjoyed a 60% rally over the following 12 months.
When the index fell that low in August 1998, it bounced back 44% in the following year.
The index got a small boost this week as experts started stocking up on the cheap shares. Morgan Stanley increased the equity allocation in its emerging-market portfolio by eight percentage points to 58%, citing "historic" low valuations.
Companies' share prices could slip a little more, but now is still a good time to buy.
"There are a lot of good companies that still have good earnings, that still have good operations, and if you're a long-term strategic investor, now's the time to get out your pencil, sharpen your list and go shopping − even if we haven't hit the bottom," said Money Morning Chief Investment Strategist Keith Fitz-Gerald.
How to Play Emerging-Market Stocks
To profit from good emerging-market stock deals, look for foreign companies that rely on domestic demand, or companies that primarily serve a developing economy.
Contributing Editor Martin Hutchinson suggests investors take a look at Chile, which he has said was the one emerging market not to ignore in 2011.
He recommends the iShares MSCI Chile Investable Market Index Fund (NYSE: ECH), for broad exposure to the MSCI Chile Index.
Another market to consider: Peru.
Hutchinson also suggests checking out Asia.
"Look at countries like South Korea and Singapore where the local governments are grown-up, the budget deficits are small, and the political risks are minor," Hutchinson said. "These countries are the AAAs of the future."
China, although much more advanced than many emerging markets, is an attractive option because it's not likely to face the same debt disasters as some developed economies.
"Check out China and anything related to or doing business because of China, regardless of where the company in question is traded – New York, London, Hong Kong, Singapore, etc.," said Fitz-Gerald. "If you are a long-term investor you want to go with the world's creditors, not the debtors. Plus most of these emerging-market countries had their own crises a decade ago, so they are not making the same mistakes again that we are making for the first time."
For investors who want to hunt for profits in more obscure emerging markets, there's a new fund from Emerging Global Advisors, the EGShares Emerging Markets High Income Low Beta ETF (NYSE: HILO). It focuses on low-volatility companies with a beta less than one and companies with high dividends. About 90% of the companies in the ETF have had increasing dividends since 2008.
The fund also strips out two of the usual countries included in emerging-market ETFs: South Korea and Taiwan. EGA President Robert Holderith said they no longer view those nations as true "emerging markets." This lets investors get their hands on the "next" emerging-market stocks.
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