I’m guessing you’ve heard some of the same comments I’ve been hearing recently regarding the weak start that many emerging markets have made this year: “It’s time to buy developed markets again,” “Emerging markets are done,” “The emerging market rally is over,” etc.
Nothing could be further from the truth. The secular bull market in BRIC markets and other smaller, organically growing emerging markets is far from over.
Markets that are developing their domestic economies based on sustainable “savings-and-investment” economic growth cycles, rather than on unsustainable, ever-rising levels of borrowing such as we’ve seen in many developed markets (Germany being a notable exception), have plenty of upside ahead.
In the United States, we saw corporate profits hit an all-time high at the end of 2010, with financial firms showing some of the biggest gains. However, this is hardly surprising when you borrow at zero percent and lend at a positive rate. Corporations reported an annualized $1.68 trillion in profits in the fourth quarter. This is almost exactly the size of the projected deficit for fiscal year 2011 of $1.65 trillion. So, in effect, the federal government has borrowed the total profits of the U.S. economy!
Before the financial crisis, we had a smaller federal deficit, but then it was consumers and corporations that were doing the borrowing. In short, if the government borrowing goes away, so does the recovery.
It is very difficult to advocate holding an S&P 500 index fund in the next 10 years, as the last 10 years has produced an annual return of just 3.2%. As you can see in the chart below, there is only one market in the MSCI Emerging Market Index with a lower return in that time frame (Taiwan), while the rest have been spectacular performers without running huge and unsustainable fiscal deficits.
|MSCI Index||YTD||1 Year||3 Year||5 year||10 year|
Now let’s take a look at some of the best emerging market stock picks.
Russia Leading the BRICs
The best-performing BRIC market for the first quarter was Russia, largely due to the surge in oil prices and signs that the Putin/Medvedev team is warming up to investors in the vast natural resources sector. As I’ve mentioned, I like Lukoil (OTC: LUKOY) a lot. But those interested in Russia for the long haul should also keep Gazprom (OTC: OGZPY) in mind. The stock has been exceptionally strong in 2011, trading at a new 52-week high as I write.
Since Gazprom is the largest company by market capitalization in the Russian market, the extreme relative strength we are seeing likely signifies a major institutional investor allocation into Russian equities. And this is probably a phenomenon that will continue for longer than the current quarter, which makes the stock a good one to hold in the current environment. After all, Gazprom has the largest reserves of hydrocarbons of any publicly traded company in the world.
For investors looking for broader exposure to the Russian market, I would consider the Market Vectors Russia ETF (NYSE: RSX).
India Making a Comeback
January was a horrible month for Indian investments, but they have bounced back a lot since, and I think that the comeback is far from over. As long as the Indian central bank is trying to slow credit growth, the Indian market will be in a trading range, a process that I think should play out in 2011.
Surging oil prices are a problem for India, considering that the country imports about 70% of its oil, and the price of crude isn’t likely to decline much in the present environment. Still, quality investments on sale — such as Tata Motors (NYSE: TTM) and the Market Vectors India Small Cap ETF (NYSE: SCIF) — make sense at present levels.
Brazil Good for the Long-term Investor
Brazil is one country that does have a lot of oil, and the performance of Petrobras (NYSE: PBR) clearly shows that the higher oil goes, the better it is for the Latin American energy giant. This is because of the very high (but still unknown) costs associated with the development of its deep-sea oil fields. This is the perfect long-term holding for believers in the peak oil theory, as the high costs will still be worth it in such an environment.
For a Brazilian company with a more certain earnings profile, consider Banco Bradesco (NYSE: BBD), which benefits from increased lending to consumers and corporations as the Brazilian economy develops on the heels of high commodity prices and prudent government reforms. The shares trade at 10 times forward earnings and 2.7 times book, which is a good value for a rapidly growing bank.