The Fed Gives The OK To Load Up On Emerging Markets

By Aaron Levitt | September 24, 2013 AAA

After being one of the stock market’s darlings for the last decade or so, emerging market nations took a break over the last few weeks as investors prepared themselves for the eventual end of Federal Reserve easing programs. With Fed Chairman Ben Bernake's recent decision not to taper bond purchases as early as expected, a fire has once again been lit under emerging markets. Investors may want to plow back in.

No Taper Yet

Here's why:

First, as the Fed has lowered economic growth forecasts for the U.S., the various bond buying programs could last well into 2014. That fact is certainly intensified by the prediction that “dovish” Janet Yellen is almost guaranteed the next Fed chairman spot after Bernanke. Her background suggests that easing programs could be on the table for quite a while until unemployment drops further and economic growth accelerates.

In addition, aside from the obvious “cheap money” that will continue to push up emerging market equities and bonds higher, emerging markets still look good on a number of fronts. The recent declines have pushed valuations into the bargain territory. Looking at P/E ratios, the sector is currently trading at a 35% discount to developed markets. This is significantly lower than the historical norm. That discount also extends to other metrics like price-to-book and price-to-cash flows.

Despite this cheapness, much of the emerging market growth story remains valid. Rising middle class populations, commodity wealth along with fiscal discipline are still hallmarks of the developing world.

Upping Exposure

Broad sector measures such as iShares MSCI Emerging Markets (NYSE:EEM) or the Vanguard FTSE Emerging Markets ETF (NYSE:VWO) are still the easiest and broadest routes gain exposure.

The PowerShares DWA Emerging Markets Technical Leaders ETF (NYSE:PIE) could be one of the best ways to get the most bang for your Fed buck in the sector. This ETF ranks its components based on relative strength traits. That means it bets on faster moving emerging market companies like Companhia de Bebidas Das Americas (NYSE:ABV) and HDFC Bank (NYSE:HDB). Top nations include Indonesia, Thailand and Turkey. The fund jumped nearly 5% on the day Bernanke announced that he wasn’t going to taper. PIE’s expenses run 0.90%.

A recent research paper by the Federal Reserve Bank of New York showed that large-scale asset purchases have the effect of pushing investors into emerging market debt. That means both the iShares JPMorgan USD Emerging Markets Bond (NYSE:EMB) and WisdomTree Emerging Markets Local Debt (NYSE:ELD) could be big buys as the Fed continues to stimulate. Both make direct bets on emerging market bonds with dollar and local currency exposure, respectively.

Finally, perhaps the biggest discount in the emerging world can be found in the BRICs. Brazil, Russia, India and China have been hit especially hard as many investors abandoned their growth stories. The SPDR S&P BRIC 40 (NYSE:BIK) tracks 40 of the largest companies in these nations and can be used to gain extra exposure to the titans.

The Bottom Line

The emerging market nations have been hit hard this year as tapering concerns have caused investors to flee risky assets. However, with the Fed signaling that quantitative easing is still very much on the table, the sector should continue to rally into the New Year. For investors, making a play in the developing world could be a big portfolio win. The previous picks- along with the Schwab Emerging Markets Equity ETF (NASDAQ:SCHE) –make ideal selections.

Disclosure: At the time of writing, the author owned shares of VWO

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