The emerging markets are in the best economic shape they have been in for years and they offer something that the developed world does not—explosive growth and dynamism. John Stephenson picks three stocks to increase your exposure to and profit from emerging markets.
A nosedive in the US dollar is fueling a rally in emerging-markets assets. Since the start of this year, the US dollar has fallen more than 8 per cent against a basket of currencies, according to data from the Federal Reserve. The dollar has been falling for some time, touching a 33-month low recently.
The tumble in the greenback is good news for emerging markets, because their dollar- denominated debts become cheaper to service, roll over and pay back. As well, research has shown that international lenders are more willing to lend whenever the US currency falls. Meanwhile, developing-market economies are in good shape, adding to the positive view of these markets.
The primary driver of the US dollar’s decline has been a narrowing of the differential in market expectations for economic and monetary policy. During the past few months, actual and expected growth has picked up in Europe and Asia, both in absolute terms and relative to the United States.
The value of emerging-market stocks and bonds has surged. The MSCI Emerging Markets stock index has returned more than 30 per cent this year, compared with 15 per cent for the developed market MSCI World Index and 13 per cent for the MSCI USA.
Bright outlook for emerging economies
That outperformance of emerging markets versus developed markets is likely to continue as the US dollar stays weak. Stubbornly-low inflation will likely ensure that the US Federal Reserve’s easy-money policies stay in place for longer, putting downward pressure on the currency.
The outlook for emerging economies has brightened, compared with last years, as a recovery in commodity prices helps Brazil, Argentina and Russia climb out of recession. Meanwhile, the expansion of giants such as China and India is set to remain robust—a relief for many investors, who for years had feared a sudden slowdown in Chinese growth.
Since the late 1990s, emerging market equities have usually outperformed when the dollar declined and struggled when the greenback rallied.
This is in contrast with large-cap, developed market indexes, which usually move in lockstep with the dollar since the multinational firms they track get most of their revenues in foreign currencies. Emerging countries are different, because their dependence on the dollar credit is greater, and a strengthening greenback makes it costlier to roll over loans. That offsets any gains from higher overseas income.
Little fear of sell-off
It isn’t just that borrowing gets more expensive. International lenders—who also rely on dollar funding—can often close their wallets whenever the value of the US currency goes up, according to research by the Basel-based Bank for International Settlements (BIS). That can hit emerging markets the hardest.
Emerging market countries are not all created equal. Some have borrowed more heavily in foreign currencies than others. For example, by share of bonds outstanding made up of international securities issued in foreign currencies, Turkey is the most exposed at 46 per cent, BIS figures show, followed by Peru and Argentina both at around 43 per cent.
Foreign borrowers are also benefitting from low-dollar lending rates. Yields on 10-year Treasuries are now below 2.2 per cent, down from 2.5 per cent at the beginning of the year.
For emerging markets, the situation is radically different from last year, when the prospect of higher fiscal spending in the US boosted the dollar and Treasury yields. That led to a fear of an emerging market sell-off, like in 2015, when the MSCI Emerging Markets Index dropped 17 per cent on concerns over the Chinese economy and the end of monetary policy designed to stimulate.
What I Recommend
With growth accelerating outside of the United States and the US dollar likely to remain broadly stable towards year-end because of the US Federal Reserve’s caution, the time is ripe for boosting your portfolio with some exposure to a dynamic subset of the global equity continuum.
One company that I really like is Alibaba Group Holding Limited (NYSE—BABA), a China-based online and mobile e-commerce company. It runs a platform for third parties and does not take part in direct sales, hold inventory, or compete directly with its merchant base. Alibaba’s retail marketplaces platform currently serves 350 million active buyers and 8.5 million active sellers. Alibaba’s platform provides the technology, infrastructure and marketing tools to help businesses of all kinds create an online presence and conduct online wholesale and retail commerce. Alibaba currently enjoys a dominant 80 per cent share of the Chinese consumer e-commerce market. Almost all (90 per cent plus) of Alibaba’s revenue has been generated in China to date. And with a burgeoning Chinese middle class and an enormous population to start with, the prospects look fantastic for Alibaba. I have a ‘buy’ rating and a twelve-month price target of $215 per share for the Alibaba Group.
Another name that I really like is Baidu Inc. (NASDAQ—BIDU), the Chinese version of Google. The company operates a search engine offering algorithmic search, enterprise search, news, MP3 and image searches, voice assistance, online storage and navigation services. Baidu serves clients globally. It also operates China’s largest internet search engine by both number of users and annual revenue. The company attracts more than one-third of China’s online-ad spending and is likely to continue reviving sales and margin growth this year. That could accelerate with improved online search functions powered by artificial intelligence (AI) and new products such as its news feed. Baidu is de-emphasizing its online-to-offline businesses in favor of longer-term bets on AI, self-driving cars and cloud services. Margins are likely to benefit from this pivot in the near term. I have a ‘buy’ rating and a twelve-month price target of $280 per share on Baidu Inc.
While Citigroup Inc. (NYSE—C) is not an emerging-market company, it is the least United States-centric bank of the US money-centre banks. Citigroup is a global, diversified financial services holding company with $1.9 trillion in assets. Its businesses provide consumers, corporations, governments and institutions with a broad range of financial products and services. Citigroup has approximately 200 million customer accounts and does business in more than 160 countries and jurisdictions. Citigroup has been the laggard among the US money-centre financial stocks, and investors have only recently started to notice. With their legacy issues now in the rear-view mirror, and a valuation gap between Citi and the other bank stocks, now is the time to build a position in Citigroup. I have a ‘buy’ rating and a twelve-month price target of $75 per share for Citigroup Inc.
With the US dollar range-bound and the Federal Reserve sitting on the sidelines, now is a good time to increase your exposure to emerging markets. The emerging markets are in the best economic shape they have been in for years, and they offer something that the developed world does not—explosive growth and dynamism.
John Stephenson is an award-winning portfolio manager and the President and CEO of Stephenson & Company Capital Management Inc. in Toronto. He is the author of “The Little Book of Commodity Investing” and “Shell Shocked: How Canadians Can Invest After the Collapse.” He is also the publisher of Strategic Investor (www.StephensonFiles.com). He can be reached at (647) 775-8360 or (844) 208-8817, or firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the September 2017/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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