Emerging markets have suffered with a widespread decline in commodity prices, slower economic growth in China and a Federal Reserve that seemed intent on raising interest rates, and that presents selective opportunities for investors betting that the worst is behind.
“The landscape in emerging markets has been steadily improving over the last few months,”
writes Geraldine Sundstrom, portfolio manager at Pimco. “Commodity prices are tentatively hitting a bottom, China’s economic transition is proceeding well and the Federal Reserve has tempered its plan to raise interest rates, and with that, the strength of the U.S. dollar.”
The
MSCI Emerging Markets Index that measures the performance of stocks in lesser-developed countries is down about 30 percent from its last peak in August 2014, but has bounced from a February bottom. Meanwhile, the Fed has indicated a willingness
to hold off on raising interest rates too quickly, which would give incentives for investors to buy higher-yielding U.S. bonds while selling emerging-market assets.
Her firm is putting money into emerging markets in three ways, she says on the asset manager’s website:
- Equities: “The dramatic negative momentum of earnings should soon end as commodity prices stop falling and purchasing managers indexes rise. Based on the MSCI EM and ACWI indexes, trailing price-to-earnings multiples for EM are at a 25% discount to developed markets, dividend yields are slightly higher, and while return-on-equity is similar, EM offers significantly higher free cash flow yields (8% versus 6%). So we think equities are a great way to get selective EM exposure.”
- Currencies: “We like a number of markedly depreciated currencies that offer yields rivaling high yield debt but with much more liquidity and far less risk of sharp price swings. These include the Mexican peso and Russian ruble.”
- Rates: “A number of yield curves, including those in Mexico and South Africa, are particularly attractive as we believe investors have priced in too many interest rate hikes.”
“Of course, some risks remain. While the C’s (China, central banks and commodities) are calmer, we will have to watch for potential storms, including faster-than-expected depreciation in the yuan or another sudden fall in oil prices,” Sundstrom writes. “Earlier in the year, we were cautious toward emerging markets but kept an open mind. Now we think the time has come to actively engage.”
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