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There’s Still Gold in Emerging Markets
May 30, 2017 by CTC Intl
The central market in Paramaribo is vibrant and exciting. Walking from stall to stall, I feel invigorated by the innovation and the dedication of the sellers, and slightly woozy from myriad olfactory and visual stimuli.
It’s a place where you can buy the uniquely Surinamese version of roti in one stall before sidling up to a seller next door hawking aphrodisiacs from the bois bande tree, or visiting the stand across the way with a dazzling selection of papaya, mango, and dragon fruit.
For buyers, it’s a smorgasbord of enticement. It’s often tempting to buy one of each just because they’re there, and they’re cheap, and they’re out of the ordinary.
The exotic third-world life — and the jaw-dropping beauty of Surinamese women — has wooed many an American to abandon their worldly possessions back home to live in this beautiful country. Unfortunately, many of them end up broke and broken, living on the bank of the Suriname River in a 1960s Airstream.
I see these types scattered around the market, identifiable by their long gray ponytails combined with native Surinamese clothing, making beads or good luck charms to sell to tourists. They look dazed, unsure how they made it from a couch in Lacrosse, Wisconsin, to a third-world destination heavy with humidity and dreams, but light on fulfillment of them.
This dichotomy — the lure of massive opportunity versus the hard fall to broken dreams — is also the tale of emerging market investors. Those sucked in early on by stories of Shangri-La returns invested in places like Brazil and Russia, only to find that when the bottom falls out, there is no safety net.
Emerging markets have been beaten up badly over the last several years, and rightly so. Corruption, lack of rule of law, creative accounting and government interference are only some of the reasons these markets have lost their gleam. There is also just the plain cold hard reality of life in the third world: It’s hard to make it big.
But that doesn’t mean it’s time to flee the emerging markets completely. In fact, it may be time to cautiously peek around the corners. There are signs that this could finally be the year emerging markets pay off, even if they don’t return to the giddy highs of the early 2000s. The iShares MSCI Emerging Markets ETF (EEM) is up 25 percent over the last year, and even the most jaundiced emerging-market watchers are starting to suggest that maybe, just maybe, things could be looking up.
But remember: There are more losers than winners, and the low (low, low) price of emerging market stocks doesn’t mean it’s time to spend willy-nilly. I wouldn’t throw my whole portfolio into the emerging market space, not now and probably not ever, but a couple of well-thought out selections could prove quite lucrative.
Remember the days when “BRIC” not only meant Brazil, Russia, India and China, but also meant dollar signs? Rapid growth, new industry, an emerging middle class, and entrepreneurship were the hallmarks of the group, and investors couldn’t wait to get in.
Not anymore. Brazil suffered a nearly catastrophic corruption scandal with petroleum giant Petrobras at the center that took down the government of Dilma Rousseff and infected almost everything around it. Russia under Vladimir Putin means government interference, falling oil prices, and opacity in the economy. China is slowing down, and is drooping under a heavy debt burden. It also looks like the country’s real estate bubble may be about to burst, and, of course, the government regularly manipulates the economy.
Yes, I know. The ruble is rallying. Brazil is buoyed. Investors and pundits note that Brazil’s economy is rebounding after the scandal, the removal of Rousseff has cauterized the government crisis, and Brazil’s economy won’t suffer if the free trade deals like NAFTA are reversed. And it is still a really big economy.
But investing in both these locations still makes me queasy.
Russia is Putin, and that makes investing there more like playing darts than making smart investments. What is safe today could face government seizure tomorrow. Prosperous companies fail instantly with a word from government, and failing companies suddenly become valuable if the Kremlin says so. That makes investing irrational, and you will find yourself analyzing Putin’s whims rather than fundamentals or trends.
Brazil may be healing from the corruption scandal, and the current government is trying its best to institute pension and other reforms, but it’s simply too early to dive in. I’m waiting until after the 2018 general election — or at least closer to it — to make bets here. The system is just still too sick for me to feel comfortable.
China is tricky, to say the least. There is no question the government games the system, and that government programs such as the anti-corruption campaign have swift and sure impact on the economy. That program essentially shut down all high-end retailers, upscale restaurants, golf courses, and even the wedding and funeral industries. All of those were thriving thanks to a growing middle class with disposable income, but with the stroke of a pen, the government changed the shape of the economy.
And things like that happen regularly in China.
But if you dig through the muck, there are some very interesting names in China, and it is hard to ignore this massive economy. Yes, there’s still risk. One way to mitigate it slightly is to focus on names on the Hong Kong exchange, not the Shanghai exchange. Hong Kong names are generally safer from Beijing interference than their Shanghai brethren.
Here are two China names for you: Tencent and Ctrip.
Tencent Holdings Ltd (HK: 700) provides communications services. It offers WeChat, which most Chinese now use for texting and calling, as well as an e-commerce platform and an entertainment platform. It is adding banking and advertising, and it continues to gain penetration in the market. All 10 analysts covering this stock give it a strong buy, and I agree. It’s a good company, with good management, and strong products that continue to adapt to the needs and demands of the market.
Ctrip (NASDAQ: CTRP) is China’s online travel site, although it also acts as an old-fashioned in-person travel agent. In February, the company announced rapid revenue growth and expanding margins. Revenue increased 76 percent year over year, and gross profit was up 87 percent. The company also announced plans to expand outside of China. While I find it unlikely that Ctrip can sustain the current pace of growth, I do believe 40 percent growth is likely over the next several years.
India is the one BRIC that remains well positioned, although even there, stock pickers reign over passive basket buyers. In other words, even in this economy, selecting individual stocks makes more sense than buying a basket of names or investing in some Indian ETF.
Under Prime Minister Narendra Modi, the economy is making tremendous strides, and I think this will continue for quite a while. The government is focused on reform and expansion, and that’s a good combination.
While there are several good names in India, one of the sectors I like the most is finance. India is moving from an economy that stores wealth under mattresses and in jewelry to a banking economy. Financial institutions are expanding into areas that never had access to banks, and the country is quickly adopting the new paradigm. In the electronic age, banking of some kind is a necessity, and Indians are flocking to open accounts.
Based on this trend, one of my favorite names is RBL Bank (NSE: RBLBANK). The company IPO’d in August last year, after a long drought of new private banks hitting the primary market. This bank has a new and fired-up management team focused on expansion, particularly in the retail and micro-finance segments, and on earnings growth. The bank is also working to increase loan growth, partially through educating the public about loan opportunities, and in increasing deposits.
Unfortunately, there’s no ADR for RBL, so if you don’t’ want to wade into investing in the Indian market, you have to wait. A good substitute for now is ICICI Bank (NYSE: IBI). The company announced earnings on May 3 which were in line with analyst expectations but earnings were below 2016 levels. In the grand scheme of things, that isn’t a problem. ICICI is one of the largest banks in India, and has strong management and a good presence throughout the country. Like RBL, ICICI is poised to take advantage of the shift toward banking and taking loans. ICICI will also benefit from its large investment in digital products, which most of its competitors have not yet focused on.
I also like Tata Motors (NYSE: TTM). The biggest growth driver for the automaker is actually the Chinese market, and we are seeing Tata make — pardon the pun — inroads here. As Chinese consumers increase their car purchases, particularly in the SUV market, I think Tata will continue to benefit. This is especially true since it purchased Land Rover. Meanwhile, Tata is doing well in the domestic market, which is also jumping in to car ownership. Tata suffered a huge hiccup in the December quarter, with profits down approximately 96%. The free-fall was due to the double whammy of lower sales in the luxury Jaguar Land Rover division as well as lower domestic sales. That pushed shares more than 10% lower. With that reset and the growth potential, I think this is another good choice.
And the Rest?
There are other strong names in emerging markets. Indonesia’s economic reforms make that country interesting. Names like Alam Sutera Realty, Bank Central Asia, and Unilever Indonesia are all worth a look.
In Mexico, the peso is down and there is uncertainty in the economy over the future of North American Free Trade Agreement (NAFTA) and questions about immigration, but there are still opportunities here. I like America Movil SAB de CV (NYSE: AMOV) because of the continually expanding Mexican mobile market, and mega cement producer Cemex.
Vietnam is still one of my favorite markets. The economy continues to strengthen, the government is selling off its stake in many of state-owned enterprises, foreign direct investment shows no sign of slowing, and the stock market continues to add new companies. I also like that changes in the investment laws mean higher percentages of foreign ownership in Vietnamese companies. One problem here is that many of the companies have very small market caps and lack of liquidity. One of the best ways to play Vietnam right now is the VinaCap Opportunity Fund (VOF: LON), at least until names like Vietnam Airlines are listed outside the Vietnam market.
Venezuela has run out of miracles. The economy has almost completely collapsed thanks to decades of Chavista economic policies topped off with price controls, shortages, and irrational economic policies by current President Nicolas Maduro. The country recently seized one of General Motor’s auto plants, suggesting it may go after other foreign-owned properties, which will further hurt the economy, which is already in cardiac arrest. The government is in crisis, so no coherent economic policy is likely in the near term. It is going to take more than inexpensive prices to make anything here interesting for quite a while.
The Point Is…
Don’t throw out all your emerging market investments. For investors willing to do the work, there are still gems out there, many of which are positioned for an upside far higher than what the developed economies can bring right now.
But don’t get lazy. Emerging markets can have a mean streak, and failure to do your homework on the front end can leave you bewildered and in despair on the back end.