Emerging markets have been written off by the majority of investors as a result of significant underperformance versus developed markets during the last three years. Even powerhouses such as China and Brazil have lost their luster when compared to red-hot U.S. equities that are continually hitting new all-time highs.
Despite those historical misgivings, emerging market equities are starting to heat up this year and may fight their way back into the limelight when everyone is looking the other direction. Often times an asset class begins to shine when the sentiment is most negative or it has been overlooked for an extended period of time.
This year, emerging market stocks have begun to finally pull ahead of U.S. equities. The Vanguard FTSE Emerging Market ETF (VWO) has gained 11.65% versus an increase of 9.40% for the SPDR S&P 500 ETF (SPY). While that outperformance may seem marginal at best, several lesser known countries have been rising to the top of this developing market spectrum. Whether by economic prosperity, changing of the political guard, or currency stability, these countries are dominating their regional peers.
One of the countries that didn’t waste any time leaping out of the gate in the first half of 2014 is the Market Vectors Egypt ETF (EGPT). This ETF focuses on just 25 companies within the third largest economy in Africa, and in fact recently graduated from a frontier market to an emerging market. Despite the fact that EGPT has just $71 million in assets, it has gained notoriety for posting an unrealized return of more than 36% so far this year.
Despite regionalized discord throughout Africa and the Middle East, EGPT has been able to overcome significant headwinds primarily through its overweight exposure to the banking and financial sector. In addition, this ETF has many of its holdings centered on small and midcap stocks that make it more susceptible to market strength.
Another area that has established tremendous momentum this year is India. The strong leadership from new Prime Minister Narendra Modi, in conjunction with currency stabilization and economic policy expansion has been a successful recipe for India stocks this year. The WisdomTree India Earnings ETF (EPI) and Market Vectors India Small Cap (SCIF) have gained 31.75% and 45.27% respectively.
Examining recent price trends, India has stabilized in dramatic fashion following its dismal performance in 2013. With superior demographics, a skilled work force, and pro-business leadership, India could prove to be an excellent growth engine over the coming decade. However, investors should also be mindful of the higher than normal price volatility and look to hold any new investment with a long-term viewpoint.
Circling the globe and focusing in on to the Pacific Rim, Indonesia has had a stellar year following a major decline of over 20% in 2013. The Market Vectors Indonesia (IDX) is currently up 26.5%, yet appears to still have a lot of room to run to reach its all-time highs. This ETF is weighted primarily towards large and mid-cap financials, consumer staples, and consumer discretionary stocks.
Indonesia stands to build on excellent GDP growth rates that exceed 5% on a year over year basis. Two thirds of their economy is driven by domestic consumption, which could continue to perform well given their stable democracy and large middle class. Indonesia also boasts one of the lowest debt to GDP percentages in greater Asian region, which should allow the government to continue its key investments in infrastructure.
Finally, stocks in the Philippines are beginning to show signs of life, with a year to date return of 23.4%. The iShares MSCI Philipines (EPHE) is dominated by 42 large cap stocks primarily centered around the financial, industrial, and telecom sectors.
Although the Thai protests last year pushed the region into a state of disarray, the Philippines has managed to overcome those fears and has held up relatively well. The Filipino economy is poised to continue its 2014 run on the back of robust economic growth, increased tourism, and a strong fiscal balance sheet.
In addition, the Filipino peso has been very strong relative to the U.S. dollar and other emerging market currencies. As a result, GDP growth has exceeded 6.5% over the last two years. These two factors bolster EPHE’s chances of trending higher in the near-term, even despite the country’s moderate levels of wage inequality and foreign investment restrictions.
No matter how you decide to invest in the resurgence of emerging market economies, it’s important to be mindful of pockets of growth and outperformance. An excellent strategy for more aggressive investors is to use funds such as the Vanguard Emerging Market Fund (VWO) or the iShares Emerging Market ETF (EEM) for broad based exposure, then pair them alongside country specific ETFs to overweight areas that present excellent risk to reward characteristics for growth. Capitalizing on recent emerging market price trends should allow your portfolio to perform admirably even if developed nations falter in the coming years.
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Disclosure: At the time this article was published, principals and clients of FMD Capital Management held positions in VWO.