How to profit from the emerging-markets slump

Right now, it’s easy to feel that there’s not much opportunity out there in markets.

The US is expensive. Bond prices are at record highs (and yields at record lows). Japan and Europe look attractive enough, but they are off their lows. In the developed world, you can argue that nothing is ‘screamingly cheap’.

But there’s always opportunity out there. Emerging markets and anything commodity-related have taken a serious hit in recent months.

So what’s going on? And is now the time to invest?

A tough time for emerging markets

The big trade for much of the first decade of the 2000s was to ‘buy stuff that’s exposed to China’. That involved investing in commodities, emerging market companies, and most China-related stuff (except, a little ironically, China itself).

But over the past five years or so, developed markets have done a lot better than emerging markets as a whole.

This is mainly a commodities story. China’s growth has slowed, and its nature has changed. China used to be buying up tonnes of commodities to pour into construction and road-building.

Now China wants to focus on building up the consumer side of its economy, which means fewer indiscriminate construction projects and a less rampant appetite for materials.

The resulting slump in commodity prices has hammered the most commodity-dependent emerging markets. Brazilian stocks have been hit hard, whereas India – which is an importer of most resources, rather than an exporter – has done rather better.

But the emerging-market slump isn’t just down to the commodities crash. It’s also been about fear of rising interest rates in developed markets – or more specifically, in the US.

With the US still looking like the developed economy that will ‘normalise’ interest rates first, the US dollar has been getting stronger as a result.

The rising US dollar has exacerbated the plunge in commodity prices. (With commodities mostly priced in US dollars, a strengthening dollar will tend to hit commodity prices.) It has also made it harder for emerging markets to attract capital.

There’s also concern over what rising rates will do to global bond markets. Across the globe, bond yields are unusually low. That’s because central banks have kept interest rates at unheard-of lows for years now.

When you’re given the opportunity to borrow money at record-low levels, it’s tempting to load up on as much debt as you can. And that’s proven the case across the board.

As John Plender notes in the FT: “Emerging market corporate bonds doubled to $6.8trn between 2008 and the end of last year, of which $1.8trn was in foreign currency. The outstanding debt of the emerging market non-financial corporate sectors has now soared to over 80% of GDP, compared with 60% in 2008.”

It won’t be much fun coping with that debt level at higher interest rates, and with a stronger dollar and weaker emerging-market currencies driving up the value of the foreign-denominated debt. Emerging market debt is one of the first things that tends to get dropped when investors are feeling nervy.

It doesn’t help that the bond market is riven with concerns about liquidity, ie everyone is worried that everyone else is on the verge of running for the exit at the first sign of trouble – which is a recipe for a crash).

So it’s easy to understand why Plender notes that now might not be the best time to pile in to emerging markets, even if some are cheap. Yes, there are many differences between markets, he says. “But as long as investors and index providers continue to treat emerging markets as if they were a homogenous asset class, the headwinds… will matter for them all, regardless.”

One emerging market to buy now

He’s got a fair point. However, I’ve always thought that one of the main benefits of being a private investor is that you can afford to take a more relaxed, long-term view of the future.

You don’t need to worry about next quarter’s performance figures. All you need to worry about is whether your investment pot will end up providing you with the long-term returns you require to meet your goals.

This matters. Fund managers can’t help but worry about market timing. One too many dud quarters and they’ll be out on their ears. But as a private investor, you don’t have to worry about getting the timing exactly right. So you can focus on more important questions like – is this asset actually cheap, and therefore likely to deliver decent returns over the long run?

Emerging markets as a whole will probably continue to suffer for now as the global economy endures the upheaval of a changing China and a nerve-wracking shift in monetary policy in the US. But if you can ride out the volatility, now might be the time to look for opportunities. My colleague David C Stevenson wrote about his favourite emerging market in MoneyWeek earlier this month.

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