Concerns about the Fed tapering its asset purchases in September are not enough to justify a pullback in the US stock market. On the contrary, there are many analysts who believe that a potential end of QE could spur an even bigger rally in equities, as investors might feel more confident about the US economy's robustness.
Nevertheless, with the S&P 500 up 150% from its 2009 lows and already up 20% this year, some might feel a little uncomfortable jumping on the US equities' ship right now. However, there are some other equity ships that will have significant upside potential over the coming months.
Emerging markets are underperforming the S&P 500 the most since 1998, when the outbreak of the Asian economic crises and the subsequent devaluation of the Ruble upset financial markets worldwide, leading to one of the most tragic events in the history of investment management: the collapse of the hedge fund 'Long Term Capital Management'.
China Slowdown Easing?
The current situation is, however, nothing like the events of 1997-1998.
Even the biggest worry for an emerging markets investor -- China's uncertain future growth -- seems to be fading. July's PMI and industrial production data came in better than expected, boosting investor's confidence. iShares China Large-Cap Fund (NYSEMKT: FXI ) , the most popular among Chinese ETFs, is trading at 9 times earnings--nearly half that of the S&P--while its price hasn't really changed so far this year.
Undoubtedly, there are uphill challenges ahead. Real estate bubbles, rising labor costs and high debt levels are still a major concern. However, if the macroeconomic picture continues to improve, and given the fact that a lot of pessimism is already priced in, you could see big gains in coming months.
An extremely punished market
These signs of macroeconomic improvement are crucial, not only for China, but also for other emerging market economies.
Up until two years ago, Brazil was the emerging world's hottest story, with rapidly improving living standards. Commodity exports to China were the main force driving Brazil's economic growth. Unfortunately, slowing demand from China and falling commodity prices have caused a slowdown in exports, hurting GDP growth and creating social upheaval. Brazilians are even protesting against the World Cup! Who could imagine that?
iShares Msci Brazil (NYSEMKT: EWZ ) is the worst-performing fund among BRIC ETFs, but I strongly believe there are reasons for a rebound. Brazil runs a surplus, so there is a lot of room for an expanding fiscal policy. Cutting taxes and increasing spending on sectors like transportation and energy could promote growth and lead to the desperately-needed revival of economic activity. The Bovespa index is down 25% since the beginning of 2013, which means that there is a 45% divergence between Brazilian and US equity markets. Either we have a huge opportunity here, or the market has correctly discounted the headwinds of the Brazilian economy. I choose the former.
A more diversified approach
A more conservative option, appropriate for investors who want to have a broader exposure in the emerging markets, is the Vanguard FTSE Emerging Markets ETF (NYSEMKT: VWO ) . The fund is primarily invested in large-cap equities, and some of its top holdings include Samsung, Bank Of China and China Mobile. Also, it is appropriate for income-oriented portfolios as it offers an attractive 4% dividend yield.
Fixed-income investors should seriously consider iShares JPMorgan USD Emerging Markets Bond (NYSEMKT: EMB ) , an ETF designed to track the performance of JP Morgan EMBI Index. The index measures the total return performance of US-denominated sovereign bonds issued by emerging markets' countries. Many of these countries' fiscal position is much better compared to some of their counterparts in the developed world. However, past events like the 1998 crash, along with political instability, have shaken investors' confidence. As a result, many of those bonds offer high yields and are considered to be great opportunities for fundamental-driven portfolios.
The bottom line
I think that the emerging markets present one of the biggest opportunities in the equity markets this year. China's problems seem overplayed to me, and even if the slow growth scenario prevails, there is limited downside risk at these levels. This bull market seems to have more room to run, and the developing world cannot underperform forever.
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