Emerging markets have been one of the worst places to invest your money so far in 2014. While stocks worldwide have struggled with increased volatility, the MSCI Emerging Market Index is down 5.8 percent, even as the S&P 500 Index clings to a 1.4 percent gain.
But now there are signs the tide may be turning in favor of select emerging markets.
Institutional money has been flowing back into stock markets in several developing nations, particularly faster-growing economies in emerging Asia.
Even some of the hardest hit countries, rocked by political upheaval, are enjoying equity inflows once again. But as always, you have to be very selective when it comes to following the so-called smart money flows.
* Overseas investors have poured a net $1.6 billion worth of fresh cash into stock markets in Thailand, the Philippines and Indonesia so far this month.
* Larger Asian markets are gaining even more attention with stocks in India attracting $2.4 billion in net cash, while investors in Taiwan stocks added $1.3 billion during March.
* Meanwhile, one of the best-performing Asian stock markets in 2013, Japan, has experienced steady outflows. Investors have pulled $7.1 billion out of Japanese stocks in March and $19.5 billion in net outflows year-to-date.
It’s a stunning reversal from just a few months ago, when global investors were scrambling to buy stocks in Japan and were running away from Asian emerging stock markets. In fact, the recent capital inflows to Thailand, the Philippines and Indonesia contrast sharply with $4.2 billion of cash withdrawals from those very same markets during the fourth quarter of 2013.
What is the catalyst for such a sharp reversal of fortune for emerging Asia?
According to a recent Bloomberg story “the combination of easing political unrest in Thailand, a shrinking current-account deficit in Indonesia and slowing inflation in the Philippines is convincing foreign investors that the economies are strong enough to weather reduced Federal Reserve stimulus.”
Indeed, the reversal in capital flows is largely thanks to a fundamental improvement in the economic data for these emerging Asian nations, combined with very attractive valuation.
In fact, India’s stock market is nearly 5 percent below its 2013 peak, while shares in Thailand and Indonesia are 25 percent below their 2013 highs.
Indonesia’s current account deficit is shrinking while its economy is expanding 5.7 percent, ahead of the average emerging market economy, and far ahead of U.S. GDP growth of just 2.5 percent.
Indonesian stocks seem a bit pricey with a P/E ratio of 15 times estimated earnings this year … until you realize corporate profits are expected to surge 39.7 percent over the next 12 months, and grow another 19 percent next year. Meanwhile, S&P 500 earnings will be lucky to grow 8 percent in 2014.
Thailand was rocked with political protests last fall, and investors responded by withdrawing $3.8 billion from Thai stocks from November 2013 through the end of last month. Declining share prices reduced the valuation of Thailand’s benchmark SET Index to just 12.5 times estimated earnings over the next year, down from almost 15 times earnings last summer.
Thai stocks offer a dividend yield of 3.5 percent, above the emerging market average of 2.9 percent and well ahead of the 1.9 percent yield on U.S. stocks.
Finally, India has attracted steady equity inflows throughout the Fed taper scare that caused panic in other emerging markets. Foreign investors have purchased $2.8 billion of Indian stocks year-to-date, and $12.8 billion over the past 12-months.
It’s easy to see why big-money investors find India an attractive destination.
India’s economy has gotten a lot more competitive in global markets with a rapidly growing, well-educated and upwardly mobile middle class. Plus, its relatively low labor costs make India a favorite destination for outsourcing. Its economy slowed a bit, to a still respectable 4.7 percent growth rate, as India’s central bank raised interest rates to combat inflation.
Longer term, India has excellent growth prospects with a robust economy likely to expand 6 percent plus. Inflation may have peaked as February wholesale prices rose at the slowest rate in nine months, and India’s stock market is already responding.
Over the past six months India’s stock market has gained nearly 6 percent while the MSCI Emerging Market Index is down 9.4 percent. So far this year the PowerShares India ETF (PIN) has gained 3.3 percent, while many other emerging market ETFs remain under water.
Bottom line: As always, you must be very selective when investing in emerging markets. But several emerging Asian stock markets look attractive. Fast-growing economies, robust corporate profit growth, cheap valuations — courtesy of the Fed’s tapering trauma — and now positive institutional money flows make several emerging market ETFs worth considering.