Fund tracking firm EPFR Global reported inflow of $4.2 billion into the emerging-market equity and bond funds for the week ending April 2. A week after, $4.9 billion flowed in. That helped inflows into emerging market funds reach a 61-week high. Emerging market equities also witnessed the first fund inflow in 22 weeks in the Apr 2 week.
This is in sharp contrast to how the year began, as previous data quoted $40 billion worth of fund outflow from emerging market equity funds in the first quarter. The outflow had in fact more than doubled from first quarter of 2013.
Also, iShares MSCI Emerging Markets Index ETF (EEM) is showing strength now. This ETF tracking index had dropped 1.9% from the beginning of the year till Mar 31. Since Apr 1, the MSCI Emerging Markets Index has moved up almost 2.5%.
While there are analysts arguing how the rally will ‘run out of steam,’ there are also opinions about why it is an ideal time to invest in these economies. Let us take a look at the turn of events affecting emerging markets so far this year before picking 3 winning stocks.
Looking at some of the emerging nations, iShares MSCI Brazil Index ETF (EWZ - ETF report) has jumped 5.5% so far this month as compared to a 0.8% increase from the beginning of the year till Mar 31. Mexico has also shown promise and Egyptian stocks have rallied strongly over the last one year.
Indonesia’s significant trade surpluses strengthened its currency and boosted growth. India’s deficit shortfall estimate is half of what the nation saw last year at $88 billion. India has also boosted its borrowing costs.
Russia has also shown improvement with its currency and benchmark rebounding from the lows hit owing to the Crimean crisis.
Factors That Affected Emerging Economies
The reference to Russia brings us to the factors that were affecting the emerging markets this year. The Federal Reserve’s tapering of the bond repurchase plan, the Russia-Ukraine crisis and dismal Chinese economic data are the key cases in point.
The original $85 billion asset-repurchase plan of the US Federal Reserve now stands at $55 billion. This is the result of the central bank’s decision to chop $10 billion from the third quantitative easing plan every month.
The International Monetary Fund had warned in January that trimming the stimulus plan could be a potential threat of more adversities for emerging economies. IMF managing director Christine Lagarde had called it to be “a new risk on the horizon and it needs to be closely watched.”
Most emerging nations have depended on cash inflow as the source of financing their growth. The Fed taper meant foreign investors pulling money out of these economies. The currencies were to go weaker and it did happen.
On top of respective political issues in the emerging economies, the Fed taper was an added headwind. At the beginning of this year, emerging market currencies suffered their worst sell-off in five years. Argentina’s peso had its worst fall since 2002. A threat to the stability of the government in Turkey dragged its currency to record lows. Separately, Hryvnia, Ukraine’s currency, dropped to a four-year low. South Africa’s Rand saw itself weakening beyond 11 per dollar for the first time since 2008.
However, some currencies showed strength later. Indonesian Rupiah, Indian Rupee and Turkish Lira are now up 7.3%, 2.7% and 0.9% year to date, respectively. South Africa’s Rand has offset all its loss and is now up 0.02% year to date. Brazil’s Real had hit a five-month high earlier this month and is now up 6.6% so far this year.
Russian Ruble and Ukrainian Hryvnia are nonetheless down 7.8% and 27.1%, respectively, year to date.
Much of the decline in Russian and Ukrainian currency can be attributed to the Crimean crisis. The crisis at its peak had dragged Russia’s MICEX down by 12% over a month (mid Feb to late March). Russia’s Ruble had at a point slumped 10%. Russia's central bank had to step in and it hiked interest rates to 7% from 5.5%.
The Ruble and MICEX are now up 2.2% and 2.7%, respectively, in the last one month.
Chinese Economic Data
Chinese economic data have been mostly dismal since the beginning of 2014.
Reports of larger-than-expected decline in Chinese exports earlier this year had raised concerns of a slowdown in the world’s second-largest economy. The anxiety further intensified after the Chinese government reported lower-than-expected yearly increases in industrial production, fixed asset investment and retail sales of 8.6%, 17.9% and 11.8%.
Earlier this month, China's State Council has promised of new measures to match the annual growth estimate. There were announcement of plans to increase spending on railways, low-income housing and tax relief for small businesses.
Last week, the Chinese government reported that the world’s second-largest economy grew at 7.4% in the first quarter, more than the analysts’ expectation of an increase by 7.3%.
Time to Sell or Buy?
Morgan Stanley (MS - Analyst Report) cautioned investors to not “chase the rally.” On the other hand, JP Morgan Asset Management believes it is “an attractive point.”
“The catalyst for the rally has been the ending of an unprecedented period of fund outflows from the asset class rather than an improvement in fundamentals," stated Morgan Stanley. In fact, the current earnings season may be the reason behind the end of the emerging markets’ rally. The bank has a 12-month forward earnings per share outlook for the emerging market index of $92. This is short of the consensus estimate of $96. Moreover, Morgan Stanley foresees strength in US dollar riding on improving domestic data.
However, JP Morgan Asset Management is bullish about the emerging economies based on the “extremely cheap” nature of the emerging market shares right now. JP Morgan notes that the MSCI Emerging Markets index has a price-to-book ratio of below 1.5. This is the lowest level in seven years.
Moreover, JP Morgan noted that whenever the valuation dropped below that mark since 1995, the equities have returned over 10% over the next one year. Following intense selling pressures, the emerging market equities had returned 27% and 30% over a year in Jul 1996 and Nov 2002, respectively.
A Bank of America-Merrill Lynch fund manager survey also shows that fund managers are less cautious on emerging markets. Only 13% took underweight positions as opposed to 31% in March.
3 Emerging Market Stocks to Buy Now
The troubles seem to be making less impact on the markets now as the currencies are gaining strength and the funds are witnessing inflows. So, it is an ideal time for investors to add some emerging market stocks. We have screened for stocks that have top Zacks Rank, Price/Sales ratio of less than 1 and PE (F1) lower than 20.
Tata Motors Limited (TTM - Snapshot Report) is the largest automobile company in India. It is also the fifth largest truck manufacturer and the fourth largest bus manufacturer in the world. It also provides automotive solutions. Commercial and passenger vehicles are also sold in Europe, Africa, the Middle East, South East Asia, South Asia, Russia and South America.
Tata Motors holds a Zacks Rank #1 (Strong Buy). The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 8.72 and it has a Price/Sales ratio of 0.64. The current year growth estimate stands at 26.6% as compared to industry’s growth estimate of 11.1%.
JinkoSolar Holding Co., Ltd. (JKS - Snapshot Report) engages in the design, developing, producing and marketing of photovoltaic (PV) products in China and internationally. This company sells its solar modules to distributers, project developers, system integrators, and other players in the solar industry.
JinkoSolar holds a Zacks Rank #2 (Buy).
The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 8.17 and it has a Price/Sales ratio of 0.72. The current year growth estimate stands at 110.7% as compared to industry’s growth estimate of 32.5%.
Embraer SA (ERJ - Analyst Report) is a Brazilian developer of jets and turboprop aircrafts. Embraer sells them to the defense aviation markets Brazil, North America, Latin America, the Asia Pacific, Europe, and also internationally. The company is also engaged in research and development of military defense and security aircraft.
Embraer holds a Zacks Rank #2 (Buy). The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 14.55 and it has a Price/Sales ratio of 0.97.
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