Can China Lead Emerging Markets Out of "The Valley"?

September 19th, 2013
in contributors

The Middle Kingdom Breaks Ranks

Investing Daily Article of the Week

by Ben Shepherd, Investing Daily

The MSCI Emerging Market Index is down by about 12 percent since May, but it has regained some ground as good economic news emerges from China.

Chinese trade growth ticked up in August, with exports rising 7.2 percent year-over-year. Notably, exports to the US rose 6.1 percent. Import growth remained slightly sluggish, though, up 7 percent from the same month last year but down from the 10.9 percent reading in July.

An improving Chinese economy helps allay growth concerns in emerging markets, but a lot still hinges on when the US Federal Reserve decides to start stepping back its quantitative easing efforts. Much of that hot money has flowed into emerging markets, which have barely had to work for it as investors sought out yields, and a reversal of those flows will undoubtedly cause problems.

Follow up:

Countries such as India and Brazil are highly dependent on capital inflows to fund growth; they’ll certainly take a hit from slowing, or even a reversal of, money flows. But as I’ve repeatedly asserted in previous issues of this publication, I can’t see a full-blown crisis developing.

Unlike the situation during the great Asian currency crisis of the late 1990s, deficits and overall debt levels in many emerging market countries are significantly lower than they were in those days. At the same time, fewer countries are pegging their currencies and emerging markets currently have an estimated $7.5 trillion in currency reserves.

The emerging markets also enjoy a significant demographic advantage over the developed world, with their bulge brackets falling within working-age ranges rather than skewing towards older individuals who aren’t likely to be working.

On top of that, as we’re seeing in China, a developed market recovery is clearly underway. The fact that America’s recovery has been the weakest in the post-World War II period isn’t up for debate, but it has also been one of the most maligned.

While much is being made of sub-3 percent gross domestic product growth in the US, few analysts are giving the economy its due for growing at all. It’s a bit like looking a gift horse in the mouth and represents amnesia about the severity of the Great Recession of 2008-2009.

Even Europe is expected to continue emerging from its recession in the coming quarters, as data show a pickup in activity in its industrial heartland. That will help underpin demand for commodities and all manner of raw materials, the cornerstone of many emerging market recoveries.

Conditions just don’t seem right for a major emerging market crisis à la 1997. I suggest that you continue holding your emerging markets stocks, if not adding to them.

That said, it never pays to totally ignore what the market is telling you and right now the message is that it’s clearly worried. But just as in the developed markets, there are defensive plays and those have held up extremely well during the sell-off of the past few months.

Mindray Medical International (NYSE: MR), in the defensive health care sector, has gained nearly 7 percent during the same period in which the MSCI Emerging Markets Index has sold off. Mindray is a maker of multifunctional health care devices such as patient monitoring and lab equipment. The company’s products mostly fall in the mid-priced range, which has helped propel sales, particularly in its home market of China.

Brazilian poultry, pork and beef processor BRF SA (NYSE: BRFS) is also up by almost 8 percent over the same period. When it reported earnings at the end of August, revenues were down on a sequential basis, which is to be expected due to seasonal factors. However, they reached BRL7.1 billion versus BRL6.8 billion in the same period last year. Earnings per share were up to BRL0.24 billion versus BRL0.01 billion in the prior year.

Thanks to growing incomes across the emerging markets, consumers have added more protein to their diets. At the same time, they’re beginning to suffer from more of the lifestyle diseases that afflict their Western counterparts, driving demand for medical care. The same circumstances that make health care and consumer staples defensive sectors in the developed world carry over to the emerging markets.

So while more discretionary sectors are likely to continue to be laggards as Fed speculation continues, there are still ample opportunities to be found in the emerging markets, particularly as this recent sell-off helps to make valuations much more attractive across the regions.

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