Could Brexit Reignite Emerging Markets?
Brexit

The Brexit vote is now behind us and the markets have fully recovered from the two-day devastation caused by the surprising result. But that doesn’t mean it’s time to jump back into U.S. or European markets. There is still a great deal of uncertainty surrounding Europe and Britain as they figure out what relationship they will have moving forward.

Even the United States is heading into increased volatility as the election approaches. Whether Donald Trump or Hilary Clinton emerges victorious, the markets are likely to respond negatively. With the world’s major markets looking hopeless for the second half of 2016, emerging markets are appearing more attractive.

Emerging Markets

Emerging markets are an all-encompassing term used when referring to developing economies such as China, India and Latin America. China and India continue to be the two fastest growing economies with the largest amount of people and resources devoted for global trade. Given how quickly they have grown, it’s only a matter of time before either nation makes the leap to advanced economy. But let’s not get ahead of ourselves, both are still very much considered emerging markets.

China hasn’t been at the top of many investor’s lists lately after its market crashed last August and growth hit its first roadblock. A number of financial fragilities are holding China down, including pressure in traditional sectors such as manufacturing and commodities. China’s response to the slowdown has been credit expansion and fiscal stimulus, but this is contradicting the government’s goals of operating a consumer driven economy. The downside risk of the economy combined with added pressure on the yuan is likely to negatively impact equities through Q3. Investor’s looking for exposure to China would safe with technology and consumer shares which have performed remarkably well this year.

If it hasn’t already, India is taking China’s crown as the world’s fastest growing economy. This year we have already seen Amazon’s (AMZN) Jeff Bezos and Facebook’s (FB) Mark Zuckerberg praise the country as the next economic juggernaut. Neither of them have been shy to invest billions of dollars to develop infrastructure in the once beleaguered subcontinent. Adding to India’s prowess has been enhanced real income growth, great spending power, lower commodity prices and interest rate cuts.

- Advertisement -

The rest of the emerging markets are unfortunately commodity driven which doesn’t bode well in the current economic environment. Commodities took a beating following Brexit and should continue to flounder in the run-up to the election. The model of growth going forward needs to mirror the development of recent Asian economies. Asia has been successful at driving consumer spending by attracting talent, capital and improving efficiency. Once promising countries like Brazil, Russia and South Africa must follow a similar path to enter the next phase of economic development. It would also help to resolve any political turmoil and corruption impeding economic growth.

Equities

Across the emerging market landscape, a number of companies have become attractive investments. Those have or are becoming global leaders in their respective industries such as India’s Tata Consultancy Service, one of the primary IT service providers worldwide. Over in Taiwan, Taiwan Semiconductor Manufacturing has positioned itself as a leader in the semiconductor industry, generating the highest margins among its peers. In South Africa, Aspen Pharmacare is revolutionizing the branded and generic drug industry for developing countries.

Many of these companies may not be household names for international investors, but it’s only a matter of time before they make it to the top of investor’s wish lists. The key to finding more hidden gems is to identify industries and companies that both operate in promising markets but also have attractive growth prospects.

Stock picking isn’t the easiest thing and when you consider overseas equities, it gets even harder. That’s why MSCI (EEM) has constructed an index that represents large and mid cap stocks across 23 emerging market countries. While China is the most represented country in the index, its mainland stocks are still excluded from the index. That means China stocks listed in the EEM index are all traded in either Hong Kong or the United States. Similar to MSCI, Vanguard has an ETF which tracks assets from emerging markets. In fact, Vanguard (VEIEX) is in the process of adding China mainland A-shares in its index, something MSCI has been reluctant to do.

Bonds

If you believe equities are too volatile, then EM bonds are a suitable alternative. In the past investors could always turn to U.S. treasures to achieve a modest yield. But after the 2008 financial crisis, central bankers around the world significantly lowered rates to stimulate growth, thereby dropping yields close to zero for high quality debt. In this environment, income seeking investors should look to emerging markets for higher yields. Across this space are bond funds that cover currencies, sovereign debt, corporate bonds, and local bonds. If you are of the mindset that the post-Brexit bounce isn’t over yet, EM bonds and even equities are more attractive.

Concluding Remarks

Emerging markets have struggled recently, but with the way advanced economies are looking this year, they are coming back in vogue. The uncertainty created by Brexit and the election is making emerging market assets even more attractive. They are not without risk though, and investors should always use due diligence before making investment decisions.

This article was originally published in Nasdaq 11 July 2016 http://www.nasdaq.com/article/could-brexit-reignite-emerging-markets-cm647140

- Advertisement -