Investment Strategies

Emerging markets offer opportunity

Despite a global recession, developing economies will likely continue to outperform

Aug 16, 2009 @ 12:01 am

By Bruce E. McCain

A number of financial trends have made emerging economies the high-growth option for international investing.

As companies worldwide have worked to reduce production costs, a wave of outsourcing has taken advantage of emerging-world capacity and fueled the growth of those economies.

To be sure, emerging markets sold off more than the developed markets when the global economy rolled into recession last year.

Now, however, we are starting to see signs that the global economic cycle is beginning to turn. As a result, we think now is the time to invest more money into the emerging international markets.

The first sign of a turnaround is a slowing rate of decline. To illustrate, long before unemployment begins to decline, we reach a point where the number of weekly claims no longer gets worse with each report.

The United States was the first major economy to enter a recession, and a variety of economic data for the United States suggest that the statistics are stabilizing — if not improving.

Credit spreads have narrowed. New home sales, and consumer spending and sentiment, as well as some of the statistics on unemployment, have all shown early signs of stabilization — and some statistics have shown signs of outright improvement.

Although many developed economies will likely remain mired in a recession for months after the United States recovers, some are showing early signs of stabilization.

It is also significant that signs of renewed life in many emerging economies are even stronger than in the developed world.

Indeed, many of these governments have poured immense monetary and fiscal stimulus into the global economy.

China, in particular, has poured an enormous amount of money into its economic stimulus program. A monetary stimulus often takes about 12 months to affect an economy. A fiscal stimulus also takes time to take effect.

The emerging signs of economic stabilization suggest that those government efforts may finally be taking hold.

The financial markets themselves provide one of the best leading indicators for the economy. Although the domestic-equity market hit a new low in March, a number of technical factors suggest that the sell-off marked a shift to a new rally.

Despite broad investor pessimism, the market didn't exhibit rising volume or other indications of expanding downside momentum. Market data, instead, suggest that the stockholders most likely to sell have exhausted their holdings and that stockholders are looking toward recovery.

Throughout the sell-off, sectors that perform well during recoveries showed strong relative performance, while defensive sectors showed waning strength.

As an indication of their strength, the emerging international markets didn't break to new lows when the rest of the world sold off in March.

Then, as the global markets rallied in April, many of the emerging markets broke above significant trend lines and have been leading the world markets. Although we recognize that significant problems remain for the global economy, it nonetheless seems there has been a clear shift of momentum.

As long as the downside momentum is waning, the risks have been reduced and we can begin building positions in the investments that we think will lead the world markets over the next few years.

Investors need to remember, however, that investing in emerging markets involves risks.

Broad diversification and specialized expertise are two important tools to help control the risks of investing in the emerging markets.

For that reason, investing through funds offers one of the best ways to take advantage of the potential of the emerging markets while keeping risks to an acceptable minimum. As an active-management option, we recommend the T. Rowe Price Emerging Markets Stock Fund (PRMSX) from T. Rowe Price Group Inc. of Baltimore.

We like the depth of its analytic commitment to these markets, and this fund does a particularly good job of capturing the upside of emerging-market rallies.

For those who prefer even broader diversification, we recommend the iShares MSCI Emerging Markets exchange traded fund (EEM) from Barclays Global Investors of San Francisco. This option may be particularly appealing to investors who seek long-term exposure and who like the idea of having greater control over the recognition of capital gains.

Bruce E. McCain is the chief investment strategist for Key Private Bank, a business segment of Cleveland-based KeyCorp.

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