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Why I'm Buying Emerging Markets

By Nate Parmelee - Updated Nov 11, 2016 at 4:56PM

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They're cheaper, growing faster, and their problems are mostly cyclical, not structural.

If you owned General Mills (NYSE:GIS) this year, take a bow. You own one of the 19 companies in the S&P 500 that is up for the year.

That's a sad commentary on how few investing ideas have performed well this year. It's also a sign that finding cheap stocks isn't a problem right now. Finding companies with strong franchises and balance sheets to weather this 100-year storm just takes focus, because the stocks that have gone down the most and look the cheapest tend to be in the weakest positions financially.

Sorting through the rubble I see some ideas that make sense now. Dividend payers with consistent cash flows yielding 4%, 6%, or more are one group that should work very well, because if markets continue to fall, the dividends provide reinvestment opportunities. I've been buying these big yields, but right now my absolute favorite group of companies is in the emerging markets.

Their problems are cyclical
The U.S. government has pumped trillions of dollars into our banks and financial markets. This won't be unwound quickly, and it's a glaring indication of the structural problems in our economy -- problems that I think will be repaired, but at a cost of inflation and a period of slower growth.

By contrast, Brazil, Chile, and China are facing slowing growth, but doing so from a stronger financial position. For them this is more of a cyclical slowdown, and as world markets gradually start to recover they should throw off the recessionary shackles sooner.

Not all emerging markets have such strong national balance sheets, though. Hungary, Ukraine, and others in Eastern Europe have been overly dependent on imports, and the financial crisis hit them quickly and hit them hard. Their long-term future still has plenty of potential, but they're not positioned nearly as well.

They're cheaper
A quick look at iShares Emerging Markets Index and S&P 500-tracking SPDRs shows the sizable valuation difference. The emerging-markets index is down 60% from its 52-week high, currently has a P/E of 9, and yields 4.6%. While the S&P 500 has also fallen hard (down 44% from its 52-week high), it still trades at a P/E of 12 and yields 2.9%.

Emerging markets are certainly cheaper than the S&P 500, but POSCO (NYSE:PKX), Vale (NYSE:RIO), and many of the other companies in the index are tied to commodities, which have struggled this year and which have a near-term outlook that is hazy to me.

My preference is to sidestep those companies for now and look for bargains in health care, consumer brands, and consumer services. China Mobile (NYSE:CHL), for example, is still adding millions of subscribers per month and with a yield of 3.8% and P/E of 13, it looks to me like a bargain. America Movil (NYSE:AMX) is doing the same in Latin America and trades at a similar valuation, but is pursuing buybacks in addition to its dividend payment.

They're going to grow faster
(NYSE:SNY), GlaxoSmithKline (NYSE:GSK), and other health-care companies are continuing to invest in emerging markets through the downturn. These companies are going where incomes are growing -- and where they'll likely continue to grow.

There are plenty of signs that the pharma companies are on the right track. Chile, which is known for its copper exports, saw its economy grow 4.8% in the third quarter on strong domestic demand, and its treasury has $50 billion saved from the commodities boom that it can use to continue diversifying its economy. Brazil is expected to post 5% annual growth this year, and China's high growth and willingness to stimulate its economy have been the subject of much discussion. Those growth rates will slow next year, but Chile and Brazil also have the ability to follow China's lead and stimulate their economies. Their domestic economies will likely become stronger, and when developed markets stabilize and start to recover, these countries are well positioned for the next up-cycle.

So there you have it: I'm buying emerging markets because they're cheaper, growing faster, and their problems are mostly cyclical, not structural.

Time to hit the road
There's an attractive emerging market just south of our border, too. Mexico's economy is closely linked to ours, so when U.S. residential construction tailed off in 2007 the slowdown was quickly felt by many Mexican companies. The financial crisis has been particularly hard on the peso of late, but I think Mexico's central bank has done a good job despite being dealt a tough hand.

Mexico has quite a few companies earning above-average returns on capital, paying big dividends, and trading at below-average valuations -- with enviable competitive positions and expansion potential throughout Latin America. That's why Mexico is the destination for our next Motley Fool Global Gains research trip. We'll be visiting companies and talking with management teams and local investors in Mexico for the next week -- and you can get all of our research, as well as our top emerging-market buys, by joining Global Gains today free for 30 days.

Nathan Parmelee is a Global Gains senior analyst. He owns a few emerging-market investments, but none of the companies mentioned in this article (yet). America Movil is a Global Gains recommendation. POSCO and GlaxoSmithKline are Income Investor recommendations. The Motley Fool is investors writing for investors.


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Stocks Mentioned

Sanofi Stock Quote
$44.24 (-9.08%) $-4.42
General Mills, Inc. Stock Quote
General Mills, Inc.
$77.52 (0.63%) $0.48
POSCO Stock Quote
$48.75 (4.17%) $1.95
Rio Tinto plc Stock Quote
Rio Tinto plc
$61.92 (0.95%) $0.58
China Mobile Limited Stock Quote
China Mobile Limited
América Móvil, S.A.B. de C.V. Stock Quote
América Móvil, S.A.B. de C.V.
$18.84 (1.32%) $0.24
GSK Stock Quote
$38.16 (-4.68%) $-1.88

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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