Things are coming together nicely for emerging markets

It could be a good time to get into emerging markets (EM) stocks. Three big things are going their way lately. What makes EMs different from developed ones?

It could be a good time to get into emerging markets (EM) stocks. Three big things are going their way lately.

I’ll come to them in a minute. But first – what makes EMs different from developed ones?

One, they tend to export a lot. Two, they tend to trade a lot with China. Three, they often fund themselves in dollars. And four, they’re heavily weighted towards commodities.

And what did we see in 2015? A slowdown in China… a strong dollar… and a commodities crash.

Not good! The strong dollar in particular was a nightmare for EM stocks. It made their dollar-denominated debt more expensive to finance, which lowered profits. And “hot money” left their home market in search of higher returns in the US.

So it was a tough year. Here’s the iShares Emerging Markets ETF:

Source: S&P

But lo! Something changed. It looks like markets have turned a corner since February.

It comes back to the factors I was talking about earlier. The dollar, commodities prices, the Chinese economy… these are all huge international forces which are out of the control of EM companies. And now all of a sudden, they’re starting to work in favour of EMs.

China’s economy hasn’t collapsed, like many people feared it would. There are signs that it’s turning the corner. The dollar has weakened a bit. And perhaps as a consequence of these, commodity prices look like they’re starting to come back. Take a look for yourself:

Source: US Federal Reserve, S&P, Markit and Blackrock Investment Institute

The left axis shows the percentage change over the last two years. The right axis shows the Chinese purchasing managers index, where a reading above 50 is “good”.

This happens from time to time in EMs. When the conditions are right they get sudden “growth spurts”, and as a group they can shoot up by 50% in a couple of years. (Needless to say, there’s huge variation within emerging markets.)

Catching that wave depends on a few things. Is China’s rebound for real? Will the Fed refrain from tightening in 2016? Have important commodities like oil found a floor?

… Those are big questions. Questions for another day.

I know a lot of UK investors don’t like investing overseas, let alone in emerging markets. What’s your view – would you be willing to put a slice of your portfolio in Burma or Brazil? Have you made money on emerging markets? Let me know at [email protected].

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