As the old saying goes, the time to buy an asset is when there is blood in the streets.
And there’s certainly plenty of red in emerging markets right now, what with chatter about Argentina on the brink of default, fears of a “shadow banking” crisis in China and a dramatic rate hike from Turkey’s central bank to stabilize the country’s currency.
Just look at these recent returns for an indication of how hard-hit emerging-market stocks have been:
- iShares MSCI Emerging Markets ETF (EEM): Down 12% during the past three months, 8% since Jan. 1
- iShares S&P Latin America 40 ETF (ILF): Down 18% during the past three months, 10% since Jan. 1
- iShares FTSE/Xinhua China ETF (FXI): Down 7% during the past three months, 9% since Jan. 1
- iShares MSCI Turkey ETF (TUR): Down 31% during the past three months, 13% since Jan. 1
But are these battered emerging markets truly a bargain after these deep declines, or are investors trying to catch a falling knife by buying into regions like these?
Emerging Markets: The Good
The biggest bull case for emerging-market stocks is simple: They are now relatively cheap, while U.S. stocks are relatively expensive after a big 2013 rally.
U.S.-listed foreign stocks (that is, ADRs on U.S. exchanges but headquartered overseas) indicate forward P/E ratios of 10 or less for South Africa, Hong Kong and South Korea right now, just to name a few. That compares with a forward P/E of about 16 for the S&P 500 right now.
Furthermore, hopes of a Western recovery could bolster export-driven economies across South America and Asia. Europe exited recession last year, and America is seeing signs of hope as housing remains strong and the unemployment rate continues to drift steadily downward.
If you believe in a secular recovery for the U.S. and western Europe, than you have to believe economic growth will trickle down into emerging markets, too.
And even if you don’t believe in a big recovery for the developed world, according to the International Monetary Fund, emerging markets make up for about 40% of the world’s gross domestic product — so if you want to play growth, these nations are a big part of that.
Every investor should probably have some global markets exposure for diversification, and emerging markets clearly have a lot of growth potential … even if there is increased risk.
So why not consider staking out a claim after these deep declines, especially in a long-term portfolio? It’s very difficult to believe that these emerging markets won’t eventually bounce back, and a bargain buy now could pay off big-time down the road.
Emerging Markets: The Bad
Stocks are “cheap” now from a valuation perspective, sure. But that’s no guarantee that they won’t get even cheaper with deeper declines, or that depressed values won’t persist for weeks or months or even years in some markets.
The reality is that the Fed’s loose monetary policy hasn’t just inflated asset prices in the U.S., but it also has pushed cash into emerging-market debt, where yields were much higher — such as Argentina bonds with a 2033 maturity that carried rates over 13% last fall, for instance.
And the prospect of winding down these easy-money policies means that cash will flow back into the U.S. once more, weakening stocks and currencies across emerging markets and increasing borrowing costs for many regions that were already pretty steep to begin with.
Consider that the Governor of Brazil’s Central Bank recently lamented that a lack of a “coordinated exit from exceptionally loose monetary policies” was to blame for turmoil in both Brazil and its neighbors.
We can debate whether the Fed accurately telegraphed its intentions to emerging markets, and whether the pace of the “taper” will be manageable enough for EM governments to navigate the shift properly going forward.
But the bottom line is that the giant sucking sound in emerging markets is the flight of capital out of these nations thanks to slower growth in these regions and a shift in Fed policy in America.
Plus, there’s a chance this trend has not fully played itself out — that the pain will persist as savers and income investors leave riskier emerging-market debt behind and return to the safe and (hopefully) higher-yielding options at home.
Emerging Markets: The Ugly
Perhaps the most troubling facet of emerging-market investing right now is the threat of contagion.