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Positive signs in emerging markets

by Community Manager

‎07-09-2014 10:51 AM

market commentaryBy Wasif Latif, head of global multi-assets

 

In the first weeks of 2014, emerging markets tanked when the Federal Reserve began tapering its quantitative easing program. Nervous investors sold en masse, fearing that a tighter monetary policy would drive up interest rates and drive down emerging market stock prices.

 

But the fear-selling proved to be short-lived. Even as the Fed has steadily cut its monthly QE from $85 billion to the current $35 billion, EM stocks have climbed 16 percent from their bottom in early February and are now up more than 6 percent for the year. Some key countries have far surpassed that average, led by India’s stock gains of more than 20 percent.

 

The interest rate scenario didn’t play out as expected early in the year, but that doesn’t mean EMs are in the clear. The World Bank last month trimmed its 2014 economic growth forecast for EMs, and their heavy (though gradually lessening) reliance on exports keeps their currencies vulnerable to rising interest rates. And if energy prices climb as a result of geopolitical events in the Middle East or Ukraine, reliant EMs could take an economic hit.  

 

Just as in the U.S., a clear picture has not yet emerged from the EM data, so what develops over the next couple of quarters may be important in helping us determine a likely direction for EM stocks in the years ahead.

 

Our analysis tells us that the investment case for emerging markets remains compelling both in the short term and over the longer term, particularly when compared to the world’s developed countries. For that reason, we have an overweight allocation to EM equities relative to the benchmark, while maintaining an underweight position to U.S. stocks.

 

 

While this year’s GDP growth estimates have been reduced for EMs, the pace of economic expansion still far exceeds that of the U.S., Western Europe and Japan, and there’s nothing to indicate that this trend will be changing any time soon. And the nature of that economic growth continues to shift. Whereas China was once content to be the factory for the world, it is now redirecting its production to meet a growing demand for goods and services at home. This powerful shift in emphasis from exportation to domestic consumption results from higher living standards and is not unique to China.

 

Looking at EM companies, fundamental valuations are still attractive even after the rally over the past five months. On a cyclically adjusted basis, the price-to-earnings ratio for EMs relative to the P/E for the Standard & Poor’s 500 is well below average. Earnings growth has not been strong in EMs, but this growth has been driven by fundamentals rather than by share buybacks, as seen in the United States. Profit margins are low, so there is room for improvement there, and EM companies are not as leveraged as their developed-world counterparts.

 

On top of that, revenue growth has been fairly decent for EM companies focused on their domestic markets, and inflation remains muted. In all, there’s plenty to feel positive about when looking at emerging markets, and that upside could be further enhanced as economic growth picks up in developed markets.

 

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 no longer cheap, 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.

 

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

 

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.

 

USAA Managed Portfolios-UMP™ is a service of USAA Investment Management Company, a registered investment adviser and broker dealer.

 

Financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License # 0E36312), and 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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