The Surprising Contrarian Play That's Worth a Second Look

Just about everywhere I've traveled, I've heard people say that if you don't like the weather, wait five minutes -- it'll change. You could say the same thing about investors and the stocks they follow. Just when you think a trend has become permanent, sentiment turns on a dime, and suddenly what investors had to have in their portfolios becomes something to avoid at all costs.

Sometimes those trend changes make sense. But often, what looks like a major paradigm shift is really just a short-term trading play that leaves the long-term strategy intact -- and gives disciplined investors a chance to get in at a more attractive valuation. That's what's happening with emerging-market stocks right now.

The emerging turnaround
Emerging markets have given early adopting investors huge returns for years. According to research from Morningstar, the average fund in the emerging-market category has returned more than 14% annually over the past 10 years. That beats developed-market international stocks by more than nine percentage points and blows away the S&P 500's 2.5% average annual gain. It's little wonder that as recently as late last year, investors were pouring new money into emerging-market mutual funds.

But now, investors are running scared from emerging markets. At the end of January, as unrest in Egypt erupted into full-scale revolt, emerging-market funds suffered record outflows. That exodus continued in February, as investors took $4.1 billion out of broad-based emerging-market ETFs, with both iShares MSCI Emerging Markets (NYSE: EEM  ) and Vanguard MSCI Emerging Markets (NYSE: VWO  ) seeing outflows.

Not all emerging-market-related investments are suffering, though. Market Vectors Russia (NYSE: RSX  ) saw the largest net inflows in the emerging-market space, as the resource-rich country attracted investors seeking to benefit from rising prices for commodities like oil and precious metals.

Anything but emerging markets
The interesting thing about the move is that investors weren't particularly discriminating about where they invested the proceeds from their emerging-market sales. U.S. stocks and developed-market international stocks saw sizable inflows, with iShares MSCI Japan (NYSE: EWJ  ) again attracting substantial assets. In addition, ongoing gains in commodities helped drive interest in iShares Silver Trust (NYSE: SLV  ) and United States Natural Gas (NYSE: UNG  ) , as well as agriculture-based funds that could benefit from continuing rises in food prices.

What's clear is that as lucrative as investing in emerging markets has been in recent years, investors are asking what emerging markets have done for them lately. In large part, the answer has been not much. Although the U.S. stock market has rallied strongly in the past six months, and despite good performance from energy stocks like Petroleo Brasileiro (NYSE: PBR  ) in light of higher oil prices, ETFs covering China, India, and Brazil didn't participate in the rally and have all seen flat to negative performance since the beginning of the year. Concerns about inflation have led all three emerging nations to raise interest rates, suggesting that their high-paced growth could slow.

Yet over the long run, emerging markets still have demographic and economic trends on their side. Improving infrastructure, media access, and technology are driving growth in India. And even though major ETFs are dominated by financial and resource stocks, a rising middle class in China and Brazil will help consumer-oriented stocks more directly than those the big ETFs own.

Stay on target
It's tempting to try to anticipate trends and try to time markets to get out at high levels in the hope of buying back in at lower prices. But if you do that, you risk missing out if some unexpected catalyst gets investors to reverse course yet again and renew their interest in emerging-market stocks.

Rather than trying to get out now, disciplined investors should stick to their long-term strategies and look to take advantage of lower prices to add to their existing stakes in emerging markets. Even if prices continue to fall in the short term, buy-and-hold investors will eventually be glad they grabbed cheap shares while the getting was good.

ETFs aren't perfect, but there are good ETFs that can help investors with their overseas investing. Click here to read The Motley Fool's special free report, "3 ETFs Set to Soar During the Recovery," which includes an international ETF that could bring you big profits.

Fool contributor Dan Caplinger loves seeing things from every angle. He owns shares of the Vanguard and iShares Emerging Market ETFs as well as iShares Silver Trust. Petroleo Brasileiro is a Motley Fool Income Investor selection. The Fool owns shares of Petroleo Brasileiro and Vanguard MSCI Emerging Markets ETF. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. There's nothing contrary about the Fool's disclosure policy.


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  • Report this Comment On March 04, 2011, at 7:38 AM, drillerjim101 wrote:

    Two emerging market ETFs worth checking into are DLS and DGS. Both are Emerging Market dividend funds with a nice track record for mirroring the S&P and paying a nice dividend with the growth. Well managed conservative plays which will add stability to a portfolio.

    Jim

  • Report this Comment On March 04, 2011, at 12:52 PM, stemcellanalyst wrote:

    Here's a real contrarian play. The entire street is betting against Cephalon right now. It has the highest short interest of almost any company in the S&P 500. Cephalon's Trillion Dollar "Off-the-Shelf" Stem Cell Drug http://j.mp/i1pYmr

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