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Why Emerging Markets Are Attractive Over the Long Term

by Community Manager

‎01-31-2014 10:54 AM

Market Commentary January 31By Wasif Latif,

Vice President, Equity Investments

 

In voting unanimously to continue reining in its monetary stimulus, the Federal Reserve this week made it clear that its focus is squarely on the U.S. economy, even if its decisions add to the current pressure being felt in emerging markets.

 

The Fed announced on Wednesday that it will trim another $10 billion of its monthly bond-buying program starting in February. In its statement, the Fed made little mention of emerging markets, which have been roiling in 2014 due to slower growth expectations in China and Brazil, vulnerable currencies in Turkey and South Africa, and political turmoil in Ukraine and Thailand.

 

Bloomberg Businessweek’s Peter Coy opened his Thursday online commentary by writing: “Emerging-market crises were supposed to be passe — a relic of the rocky 1990s. …”

 

We don’t agree with the thinking that emerging markets have somehow been transformed into crisis-free investor sanctuaries. There’s a good reason why emerging-market stocks trade at significantly lower price multiples than those in more stable, developed markets.

 

Investors put money into emerging markets in pursuit of high growth. Inherent in that pursuit is the possibility that there will be periods of high volatility. Global liquidity has major short-term impacts on emerging markets, which is why those markets are feeling the Fed’s efforts to reduce money supply, but there are also country-specific factors that more fully explain the economic circumstances  of certain nations.

 

In fact, a lack of signs of impending contagion actually shows how far emerging markets have come in the minds of investors. Not that long ago, liquidity or currency issues in one corner of the developing world would likely have spread quickly across the asset class, as we saw during the Asian financial crisis of 1997-98.

 

The size, strength and diversity of today’s emerging markets are contributing factors to our positive outlook over the longer term. They should continue to lead the world in GDP growth, and the transition of that growth from export-driven production to domestic consumption will play out over decades in China and other populous countries.

 

Among emerging markets, we see notable opportunities in South Korea, home to globally recognized companies that produce high-value goods ranging from technology to ships; Taiwan, a key technology manufacturer; and the Philippines, where foreign investment rose more than 60% in 2o13.

 

We also find Turkey attractive in the long term, based on its well-educated population and large consumer sector. But we are watching to see if this week’s dramatic interest rate hike can support the Turkish lira and if it leads to a significant slowdown in the broader economy.

 

We have been asked whether we believe the negative headlines relating to emerging markets are contributing to the recent downturn in U.S. equity markets.

 

It’s possible that some of last Friday’s sell-off (with the Standard & Poor’s 500 down about 2%) may have been related to anxious emerging markets. In our view, however, the predominant driver of U.S. market behavior is how investors interpret macroeconomic data and future earnings trends.

 

Regarding the U.S. economy, a paradigm shift occurred in the second half of 2013: Investors started believing we were on a clear path to normalization. Growth was increasing, and unemployment was decreasing. We all could see the Fed’s taper would be coming sooner rather than later. As a result of that buy-in by investors, any data point that challenges the everything-is-returning-to-normal thesis can cause disruption.

 

Earnings season could be supplying such a data point, as some companies that met or beat their number for the December quarter have guided down forecasts for coming quarters. Downward earnings guidance feeds into the belief held by many, including us, that U.S. companies may have a hard time finding the earnings growth needed to support current price-to-earnings ratios.

 

For more on how we see this year shaping up for investors, we invite you to read our 2014 investment outlook

 

USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged. We remain slightly overweight in cash in our diversified managed portfolios. For investors interested in income-oriented bond investments, the USAA Intermediate-Term Bond Fund, the USAA High Income Fund and the USAA Income Fund are examples. For investors interested in tax-free income, the USAA Tax Exempt Long-Term Fund, the USAA Tax Exempt Intermediate-Term Fund and the USAA Tax Exempt Short-Term Fund are examples.

 

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

 

Emerging markets represent another opportunity. Though they were hit especially hard recently, we believe that emerging markets remain attractive. They offer both an interesting long-term prospect for growth and compelling valuations. 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 you based on your individual goals, objectives, risk tolerance and time horizon.

 

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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.

 

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