• Financials Sector Underperforms: Although the global financial crisis began in the United States, it had repercussions around the world. While financials have been healing and performing better in the U.S. over the last three years, emerging market financials have been laggards during that time. Concerns over rapid credit expansion and the potential for a rise in bad loans seem to be most prevalent among Chinese banks, specifically regarding the “true” quality of the loans on the banks’ books. In a slowing economy, and certainly in a recession, defaults rise, and this is a potential concern for many.
Potential Emerging Market Outtakes
• Focus on Emerging Market Consumers: Investors who are steadfast in their belief that a growing middle class in the emerging markets will continue to support local economic consumption, but who are concerned about macro-sensitive sectors, should look toward the WisdomTree Emerging Markets Consumer Growth Index. WTEMCG is a fundamentally weighted index that consists of stocks that best exemplify growth trends in emerging market consumers and their local economies by focusing on stocks in the consumer growth sectors and at the same time excluding some of the more macro-sensitive sectors—especially energy and materials stocks. One of the reasons I think the stocks in WTEMCG are attractive at the present time is that they sell at a similar valuation multiple to the MSCI Emerging Markets Index as a whole, but without some of the more depressed areas such as commodity sectors or the large Chinese banks. This fact alone makes it an attractive basket to me.
• Focus on Valuations: Investors who are interested in identifying the lowest-priced sectors should focus on the WisdomTree Emerging Markets Equity Income Index (WTEMHY). WTEMHY is a fundamentally weighted index that screens for the highest-dividend-yielding stocks within the emerging markets and then weights those stocks based on cash dividends paid. Currently the methodology has positioned the bulk of the index weight in the Financials, Energy and Materials sectors, which happen to be some of the lowest-priced sectors in the emerging markets. For investors looking for the most value-centric part of emerging markets, WTEMHY currently embodies this valuation mindset.
Conclusion
I believe the recent emerging market performance and negative sentiment has created potential opportunities. While not all sectors have performed poorly, it is important to understand the relationship between prices and fundamentals. Markets may deviate from the underlying fundamental value for a number of reasons and can stay irrational for long periods, but I believe they eventually revert back to the underlying fundamentals. As a result, investors shouldn’t abandon the asset class but instead focus on an area of the market they feel confident about and do so through a rules-based strategy that focuses on fundamentals.
1Sector weight as of 12/31/13.
2Sector weight as of 12/31/13.
Important Risks Related to this Article
Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments focused in China are increasing the impact of events and developments associated with the region, which can adversely affect performance.