Four Emerging Markets That Aren't Overheating

By Aaron Levitt | July 18, 2011 AAA

The long-term promise of emerging markets is certainly great. Changing dynamics and increasing wealth are causing many of these nations to move from the fringes and into the mainstream. When the term "emerging market" was first coined by the World Bank nearly 30 years ago, these economies accounted for less than 30% of global GDP. Today that number sits at well over 50%. What's more exciting is that future estimates show that nearly 70% of the world's growth over the next few years will come from emerging markets. China and India alone, will account for 40% of that growth. Investors have taken a shine to funds like the iShares MSCI Emerging Markets Index (NYSE:EEM).

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However, uncertainty has crept back into the markets. Political unrest across the Middle East and North Africa, high inflation and concerns about slowing global growth have all contributed to push share prices lower across the developing world. While majority of the headlines would suggest that virtually all emerging economies are overheating, this simply isn't true. For investors, this leads to opportunities.

Finding Those "Cool" Markets
A recent study by the Economist may provide answers for investors on how to find emerging markets that still have room to run. Looking at six different metrics, the magazine was able to compare 27 different emerging market nations and rank their risk of overheating. For example, inflation in the emerging world has increased more rapidly than developed nations, averaging about 6.7%. Still, there is a huge spread among nations. Taiwan has experienced rather mild inflation at 1.7%, India has seen over 8% and Argentina is crippled by 20%-plus. Other metrics such as excessive credit expansion, comparing a nation's average GDP growth rate since 2007 with its growth rate in the previous 10 years and tight labor markets have produced a list of desirable and less-desirable emerging market nations.

Playing It Cool
With so much long-term potential for emerging markets, investors could use the report as way to play some of the stronger nations and avoid some of the weaker ones. The only country to score red on all six metrics was Argentina. Investors might want to bypass the Global X FTSE Argentina 20 ETF (NASDAQ:ARGT) for now. For those looking for a broad approach to emerging market investing the PowerShares FTSE RAFI Emerging Markets (NYSE:PXH) provides an equal-weighted option which helps smooth out country weightings. For those looking for individual picks, here are least likely to overheat and how to play them.

Living under Brazil's shadow in Latin America, Mexico might make a better investment choice. Rich in farmland, silver and copper, Mexico's export driven economy has thrived since the implementation of the 1994 NAFTA agreement. In addition, the nation is seeing new trade deals with China and the European Union that could help boost GDP. The iShares MSCI Mexico (NYSE:EWW) and Global X Mexico Small Cap ETF (NASDAQ:MEXS) allow investors to tap into this growing nation.

As one of the superstars in the ASEAN trade bloc, Malaysia has found its niche as a major agricultural commodity producer. The nation is the world's largest producer of Palm oil. Aside from its dominance in agriculture, the nation is an exporter of crude oil and holds many deposits of copper and iron ore. The iShares MSCI Malaysia Index ETF (NYSE:EWM) remains the only way to play the nation.

Finally, the two resource-rich nations of Russia and South Africa make the cut on the Economists list. Both have benefited from strong commodity prices, resulting in Russia's disposable household income being nearly 30% higher than Brazil's. South Africa's resource dollars have been plowed back into infrastructure spend and social welfare programs. These nations can be accessed through the iShares MSCI South Africa Index (NYSE:EZA) and Market Vectors Russia ETF (NYSE:RSX) or via their currencies the rand (NYSE:SZR) or ruble (NYSE:XRU).

The Bottom Line
While the long-term picture for emerging markets is bright, recent events have caused much uncertainty in the group. Inflation, slowing growth and political unrest are abound. However, not all emerging markets are created equal. The previous countries, along with Taiwan (NYSE:EWT), offer some of the few developing nations on the safer side. (In a volatile market, domestic investing can be risky. Many investors choose to look overseas for diversification - but that strategy comes with its own risks. To learn more, see The Risks Of Investing In Emerging Markets.)

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