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For investors, Ukraine is a local story

by Community Manager

‎05-07-2014 01:29 PM

market_commentary_base.pngBy Wasif Latif, head of global multi-assets


The escalating dispute over Ukraine’s sovereign borders is generating global headlines and worrisome what-ifs, but so far the economic ramifications have been largely local. The broader story for emerging markets investors in 2014 is the same as it’s always been: China.


The MSCI Emerging Markets Index is essentially flat so far this year, but the ride has been a wild one. The index tumbled more than 8% in the first few weeks of the year due to liquidity concerns as the Federal Reserve began tapering its quantitative easing program. But since early February, the index has regained all of that decline, even as the Fed has steadily tapered QE from $85 billion per month in December to $45 billion in May.


China, which accounts for nearly a fifth of the MSCI EM index, opened the year with a 10% fall, and since then it has followed an M-shaped course of peaks and valleys. In 2014, it is down more than 8%. Making up for China’s decline has been Brazil (+8.2% YTD), India (+7.1%), South Africa (+4.1%) and Taiwan (+3.8%).


China’s slowest GDP growth pace in many years is almost certainly weighing on stocks, as have wage and commodity costs that exert a negative impact on earnings. The flip side is that the underperformance in China has made valuations very attractive. When stocks are cheap and expectations are low, an upside opportunity is created. There comes a day when the bad news is not that bad, and when that happens, you see a re-rating of assets, and then those assets are positioned to start outperforming.


We saw this scenario play out last year in developed Europe after its banking crisis, and we’re seeing it now in the so-called “Fragile Five” emerging market countries (Brazil, India, Turkey, South Africa and Indonesia) that were battered early in 2014 over currency worries but have since bounced back. This recovery path doesn’t mean that volatility goes away, but once the data stabilizes, valuations can take on more prominence.



The situation is different right now in eastern Europe, though in the end, we could also be looking at a valuation story.


Russia, which took over Crimea and is now seen as driving a separatist movement in eastern Ukraine, has watched its currency and its stock market drop sharply in 2014. In Ukraine itself, the currency has plunged more than 30%, and bond yields are soaring as worries of civil war grow by the day. But in neighboring markets in eastern Europe, the impact is hard to see in the numbers.


There is room for the West to expand its sanctions against Russia, but because the impact of sanctions are slow to develop, they would likely take some time to be felt in the overall economy. And while Europe may oppose Russia’s role in Ukraine, it may be reticent to push too hard for harsh punishment lest it hurt itself in the process. Europe’s economy, still working to pick up growth traction, relies heavily on Russia as a source of energy and as a large and reliable market for its export sector.


From an investment perspective, history will tell you that geopolitical events can create short-term market noise and longer-term buying opportunities. Will this be the case with Russia? That’s hard to know at this point, but we are paying close attention to what’s happening in Ukraine. Given the 20% drop in stocks so far this year, it appears that the Russian market is cheap and that it could be getting even cheaper.


As long-term value investors, this is something that we can’t simply ignore. We are going through our processes, and as with any investment opportunity, we will sort through important macro factors and company-specific measures. This helps us determine if there’s a risk-reward rationale in which we and our shareholders would be appropriately compensated for any risks taken.


USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery of the U.S. economy, valuations are stretched and profit margins are near record highs.


We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate-Term Bond Fund and the USAA High Income Fund fit this profile.


We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.


We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.


As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.


This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.


Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.


Investing in securities products involves risk, including possible loss of principal.


Past performance is no guarantee of future results.


As interest rates rise, existing bond prices fall. Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities.


Some income may be subject to state or local taxes or the federal alternative minimum tax.


Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.


The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.


Standard & Poor’s 500 Index and S&P are registered trademarks. The S&P 500 Index is an unmanaged index of 500 stocks. The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market. S&P 500 is a trademark of the McGraw-Hill Companies, Inc.

The Russell 2000® Index is an unmanaged index which consists of the 2,000 smallest companies in the Russell 3,000 Index, and is a widely recognized small cap index.


USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor.


High double digit returns are attributable, in part, to unusually favorable market conditions and may not be repeated or consistently achieved in the future.


Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.


The Real Return Fund may be subject to stock market risk and is non-diversified which means that it may invest a greater percentage of its assets in a single issuer. Individual stocks will fluctuate in response to the activities of individual companies, general market, and economic conditions domestically and abroad. When redeemed or sold, may be worth more or less than the original cost.


Managed Accounts is a service of USAA Investment Management Company (USAA), a registered investment adviser and broker dealer.


Diversification does not guarantee a profit or prevent a loss.


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