Dolls And Dogs: Our List Of Emerging Markets To Invest In (And To Avoid)

With one-third of 2016 already behind us, we review the major stock market indices in frontier and emerging countries. Where were the returns strongest – and more importantly, what are the best ways for investors to get involved?  

After a long period in the darkness, investors in emerging markets have lately had reason to perk up.

Contrast that with last year, when global equity investors had few places to hide. US markets barely broke even in nominal terms, and even incurred a small loss when factoring for inflation. Pain was evident in other developed markets, as major European indices also ended the year lower. Yet these lackluster performances paled in comparison to the bloodbath in emerging markets. Note the comparisons below, as displayed with the most liquid ETFs that track each relevant index:

Data calculated as of market close on 5 May 2016

The opening days of 2016 saw that malaise transform into outright fear, as January proved to be one of the most brutal months in recent memory. US Fed Chairwoman Yellen’s decision to raise US rates at the end of December (an ill-advised tactic, as I wrote back in October) sparked a rush for the exits of stock exchanges around the globe. US and European markets lost nearly 10% of their value, while the carnage in major emerging and frontier indices was even worse.

Source: Money.net

There is an old market adage: “As goes January, so goes the market.” Yet an interesting trend has played out since that Fed-inspired selloff. Most major indices traded lower in February, then moved higher and are now positive for the year.   (Of course the exception to this rule is Europe, which is grappling with a most likely insurmountable heap of problems – most of them self-inflicted).

But most of the emerging and frontier markets rallied from their mid-January lows and have never looked back. In fact, despite a fierce selloff this week in the emerging markets (note: nearly 25% of EEM’s holdings are in Chinese equities, where many large institutions cut their holdings this week) both of these indices have outperformed those tracking the US and Europe.

So what is driving these gains? Unfortunately it isn’t economic growth, as few countries expect to produce higher growth rates in the current year.   Instead, investors seem to be rotating back into emerging market currencies which have been heavily sold in recent months. Remember last year when the ‘smart money’ was forecasting an unprecedented dollar bull market as the Fed began to raise rates? Take a look at this chart for UUP (an ETF that seeks to track the Dollar Index):

Source: Money.net

Here’s a question for the technical traders out there: If this chart were for a stock, would you want to own it? (Hint for non-traders: No).

Investors have begun to realize that the Fed has painted itself into a corner, with no conceivable way to follow up their rate-raising rhetoric with action. Consequently, emerging market currencies have been on a tear as investors move back into bonds issued by developing countries in an increasingly desperate search for yield:

Source: Money.net

Of course much of this growth can be attributed to ‘bottom-fishing’. This year’s winners are the same countries where investors sold off every asset class a year ago. Factors that contributed to the selloff were quite serious – Western sanctions (Russia), unprecedented corruption and scandal (Brazil), and presidential incompetence (South Africa), and the fear was compounded by a commodities bear market in reaction to waning demand from China.

It is quite possible – likely, even – that emerging markets investors are in the midst of a bear-market rally. There certainly are few macro fundamentals that can spark excitement – in any market. Nevertheless, as another old adage goes, “There’s always a bull market somewhere” – an old saw that has stuck with me ever since I watched the Sri Lankan stock index increase over 125% in 2009, while the rest of the world was self-immolating.

With that in mind, let’s take a look at the five best – and five worst – equity market indices in the emerging and frontier market spectrum so far this year. We track all indices that are included within the MSCI country classification list for frontier and/or emerging markets. We’ll also take a look at ETFs or ADRs that are a generally accepted way for investors to get direct access via one of the US stock exchanges.

As you can see, Latin America is dominating the field:

The Five Best

Source: Bloomberg 

Peru: Amidst an ongoing presidential election, the Lima Index went near-vertical in early April after the reigning leftist candidate failed to secure enough votes to qualify for a runoff.

Best equity plays: iShares MSCI All Peru Capped Index Fund (NYSE: EPU).  For ADRs, Southern Copper (NYSE: SCCO) is a US-listed copper miner that generates 43% of its revenues in Peru).

Brazil: No tangible bull case here, other than it has been oversold amidst the worst recession in a century and the unprecedented Petrobras scandal. A slight bump in depressed oil prices have also contributed. Look for a further rally if the Senate pushes out lame-duck president Rousseff later this month.

Best equity plays: iShares MSCI Brazil Index ETF (NYSE: EWZ). Honestly, there’s not much to love here.

Argentina: We currently receive more enquiries about Argentina than any other frontier market, except Iran. This is a definite value play – after years of financial isolation the country just closed its first bond offering in over a decade, and is about to proceed with its first IPO. As we’ve written previously, though, it pays to be cautious here.

Best equity plays: Global X MSCI Argentina ETF (NYSE : ARGT). Some interesting ADRs include integrated oil company YPF (NYSE:YPF), Banco Macro SA (NYSE:BMA) and Grupo Financiero Galicia (NASDAQ:GGAL).

Morocco: The tiny Casablanca Stock Exchange’s All-Shares Index has been on a tear over the past two weeks. Positive sentiment is building in the North African country after Bank of China announced it would base most of its African operations there.

Best equity plays: Not easy for US investors. No Moroccan companies carry ADRs; the closest proxy is the WisdomTree Middle East Dividend ETF (NYSE: GULF) which currently has a 13% weighting in Morocco. Its largest holding is Maroc Telecom, at 10% of total weighting.

Colombia: Coming off a very bad year in 2015, underpinned by the one-two punch of high inflation and lower commodity prices. Higher prices for oil have helped to ease investors back into the Bogota Stock Exchange, while US real estate investors are beginning to discover opportunities here.

Best equity plays: Global X MSCI Colombia ETF (NYSE: GXG); ADRs include Bancolombia SA (NYSE: CIB) and Ecopetrol SA (NYSE: EC).

And finally, let’s take a look at the worst-performing frontier and emerging markets so far this year. Remember that volatility is generally higher in emerging markets, and particularly in frontier markets. Today’s dog could be tomorrow’s darling, and vice versa:

The Five (Actually Four) Worst

Source: Bloomberg

Most of the names on this list are widely expected, as we show here:

Ukraine: No explanation needed. Rampant inflation, non-existent economy, and did I mention a low-intensity conflict on its eastern flank? I’ve been hearing about opportunities on the ground for the truly adventurous, but that’s about it.

Ghana: Weak currency, coupled with rising inflation. The Ghanaian economy has begun to show symptoms of ‘Dutch disease’ as government revenues move to support recent oil discoveries while leaving other industries to rot.

Nigeria: Take the Ghana explanation mentioned above, and ramp up the intensity by 10x. The current president is resisting calls to devalue the currency, the naira.

China: This is the proverbial ‘elephant in the room’ – not just for emerging markets, but globally. Stocks in the world’s second-largest economy have sold off aggressively this year amidst speculation of looming corporate bond defaults and concerns over economic growth. Continued weakness here may begin to spill over into the global economy.

In conclusion, a prudent investment strategy with regard to emerging and frontier markets might include the following:

• Consider weighting more heavily toward EM and particularly selected FM as dollar weakness continues to push assets into these markets.
• Region, and even country, selection remains important. Keep an eye on Latin America – but beware the siren song of the bear-market rally.
• Keep an eye on the data. Much of the recent gains have been driven by value investors picking up oversold assets. Without clear indicators of actual economic growth, this rally may be short-lived.

Kevin Virgil is the CEO and co-founder of Frontera.