For the first time since March, emerging market stocks are in the early stages of a new uptrend in a sign that investors are looking for fresh opportunities overseas.
This is a big reversal of recent trends. Since the beginning of April, foreign stocks have lagged the major U.S. averages on a combination of concerns over economic growth in places like China, inflationary fears, and a stabilizing dollar. The dollar’s strength also reversed the popular “dollar carry trade” that saw hedge fund types selling greenbacks and using the proceeds to buy foreign assets.
This worked great for a bit but the dollar’s bounce in the wake of the killing of Osama Bin Laden on May 1 ignited a round of short covering as traders scrambled to close positions. Losses were heavy: The iShares Brazil ETF (NYSE: EWZ) lost 12.5% from its April high while the iShares Emerging Markets (NYSE: EEM) dropped 9.2%.
As a result, valuations are now very attractive. The price-to-book ratio of the Shanghai Stock Exchange Composite Index (.SSEC) dropped to 15.3X last week, which is 9% below the average of 16.9X seen during the last three market troughs in January 1996, November 2005, and October 2008.
Here’s the interesting part: According Sakthi Siva at Credit Suisse, the drop in valuation comes despite strong earnings power. Return-on-equity is running at around 15.1% — well above the 11.4% average seen during those three lows.
Over the past week, bargain hunters have swooped in as many of the problems facing the emerging market economies appear to be dissipating. China looks set for a carefully engineered “soft landing” as growth cools enough to pull inflation lower. Credit Suisse economist Neal Soss is looking for global growth momentum to reaccelerate back to 4.5% this summer after expanding at an estimated 3.7% rate this quarter.
The obvious candidates to play the rebound via ETFs would be the EEM or the iShares FTSE China 25 (NYSE: FXI). Outside of Asia, I really like the Global X Colombia 20 (NYSE: GXG). I recommended the fund to my newsletter subscribers this week as it pushes up and out of a multi-month consolidation pattern. A move to test its previous high would be worth an 8%+ gain from current levels.
Disclosure: Anthony has recommended GXG to his newsletter subscribers.
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