This article was originally published on TheStreet.com on March 28th, 2014 at 6:00am EST
That’s right, to buy emerging market stocks.
The two most common arguments we are hearing about why the emerging markets are doomed have to do with the inevitability of rates rising here in the US and the fact that their largest trading partner, China, is slowing. I think these fears are misplaced.
The US credit markets have long been a key access point for emerging market nations’ liquidity needs. But rates aren’t rising here.
We keep hearing about how rates must go higher as our economic recovery continues to accelerate, unemployment declines, and the Fed withdraws its monetary stimulus. But the bond market is already pricing in all of these factors. Last week Janet Yellen announced that the Fed’s bond-buying program may be complete by this fall—meaning the Fed will taper its Treasury and Mortgage-Backed-Security purchases all the way to zero. She added that about six months later it might make sense to raise the short-term benchmark Fed Funds rate.
The 10-yr Treasury was yielding 2.68% the day before Yellen’s announcement; it is at 2.67% today. Here is what the emerging market index (EEM) has done versus the US (S&P500) since:
And even if rates did gradually move higher from here—let’s say the 10-yr Treasury got to 4%—who says that’s particularly ominous for emerging markets? The emerging markets rallied almost 250% from 2003-2007; the 10-yr Treasury was between 3.50 and 5.00% over that time period.
Slowing isn’t shrinking
Just like tapering isn’t tightening, slowing isn’t shrinking.
We have all seen the warning signs flashing—China is slowing. Okay, but what does that really mean? China’s GDP grew by 7.7% in 2013. China is still growing three times as fast as the United States, and their overall output for last year was $9.4 trillion (that’s more than half that of the United States’ $17.4 trillion). So the world’s second largest economy is still growing at the fastest pace, by far, of any of the major economies….and that’s bad news? The rule of 72 tells us that China’s GDP will double in 9 years—if we doubt their data or consider that the rate at which they are growing may, in fact, be slowing then maybe it will be 10-12 years. And China is the country that buys most of the emerging markets’ natural resource exports.
* China will not necessarily overtake the US in 10-12 years, as the US is also growing (albeit at a slower rate).
Low, Lower, Lowest?
What circumstances make for the best possible pricing of a security? (If you’re a buyer, the best pricing is the same as the lowest pricing.) Put simply: When all the news is bad; When you cannot find a single positive catalyst; and when there is no sensible reason for the price to start moving higher. These are indications that a security’s price may have bottomed out. Are we already past this point? Below you can see that, despite nothing but negative headlines for as long as we can remember, the emerging market index has broken above its 20-, 50-, and 200-day moving averages (this is bullish):
There are reasons to be more selective about which emerging markets you choose — rather than simply buying the entire index — but that’s a different argument. Emerging market stocks aren’t likely to get much cheaper, and just because you aren’t hearing about any positive catalysts doesn’t mean they don’t exist. The two overblown fears above not coming to pass may serve as the first chink in the bears’ armor.
Have a great weekend!
Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main
Adam Scott’s profile on TheStreet.com can be found here.