It's Time to Buy

By CHRISTOPHER C. WILLIAMS | MORE ARTICLES BY AUTHOR

After a 20% plunge in just three months, emerging markets, including China, India, Brazil, Taiwan and South Korea offer strong economic growth at a discount price.

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With markets shaking and shuddering all around the world, investors are fleeing risk as fast as they can. Normally the safe route would be limited to Treasury bonds, gold and cash. But this time around, there may be a surprising but smarter way to flee the economic sclerosis that's infecting Europe and the U.S.: Buy stocks in emerging markets.

One sign of the newfound respect being paid to emerging markets is the fact that their currencies in recent weeks have held up remarkably well against those of more developed economies. The Brazilian real, for example, rose 0.5% against the dollar last week and is up 4% for the year.

Balance sheets, too, are healthy. The Asian emerging markets, for example, have already gone through their painful deleveraging cycle, post the 1997-98 meltdown. They now have big current-account surpluses and huge reserves as a result of their being producers and savers, unlike the developed world that got in trouble from over-borrowing to maintain consumption.

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John Dykes for Barron's

Because of their better balance sheets, they could be relatively safe havens while developed markets suffer.

You wouldn't guess that from the performance of their stock markets, however, which are down 20% from their 2011 high in May and now trade at 12.6 times earnings estimates for 2011. That compares with 14.4 times for the MSCI World index of developed markets. For that price you get GDP growth, on average, of 6.3% and earnings growth of 13% -- well above the almost flat GDP growth forecast for the U.S. and Europe.

For adventurous investors, it's time to buy, though the extreme volatility of the current markets could push these stocks lower before they turn around. "Emerging markets are smaller and less liquid than developed markets, so it doesn't take much to get the stocks clobbered," says Daniel Grana, portfolio manager of Putnam Emerging Markets Equity fund. "But the companies are more profitable, faster growing and cheaper than their developed counterparts." He thinks the group is near the bottom now.

And for the record, emerging markets as a whole held up better than developed markets in last week's plunge.

For sure there are risks. Export economies, like South Korea, Taiwan and China, would be hurt if the U.S. slides back into recession. South Korea's Kospi index was trampled on Friday, falling 6.2% on renewed fears of a slowdown in the U.S. and Europe -- the biggest one-day decline since the 2008 financial crisis. Korea indeed is dependent on foreign trade, but other growing emerging markets, such as China, account for 70% of its exports.

Geoffrey Dennis, who tracks emerging markets for Citigroup Global Markets, says, "I would be surprised if we don't see a 15% to 20% gain in emerging markets between now and the end of the year."

Paul Attwood, who manages the Huntington Global Select, is similarly bullish. "Over the next five years, emerging markets will outperform developing markets," he predicts. "It's the only place you'll find significant economic growth."

Morgan Stanley is less sanguine, warning last week that the U.S. and euro-zone economies are "dangerously close to a recession." The firm dropped its estimate for 2011 global GDP growth to 3.9% from 4.2%.

Inflation is another risk. With central banks in Brazil, China and India raising rates to stem higher costs, some fear that these markets could be in for a hard economic landing. On the plus side, falling commodity prices will help temper higher costs. If inflation peaks in the coming months and begins to trend lower, as some bulls expect, emerging-market stocks could be spring-loaded for growth.

And following the pounding over the past three months, the MSCI Emerging Markets index is certifiably cheap, trading at 10 times 2012 estimates, compared with a historical average of 11.5. The S&P 500 and the MSCI World index of developed markets both trade at 12 times.

WHILE EMERGING MARKETS are lumped together as an asset class, the group is composed of a lot of disparate markets, each with its own virtues and vices. Indonesia, for example, has gained 20% a year, on average, for the past five years. Russia, by contrast, has declined at a 7% annual clip. In all, emerging markets are up an average of 4%.

What they have in common, which is absent from the West, is growth. Even after a something of a re-rating last week, Brazil is expected to grow 4% this year. China's economy is advancing at a 9% clip, and India is growing at 7%.

Among the least expensive of the emerging nations are Russia and Pakistan, which trade at five and six times this year's earnings estimates, respectively. With good reason. While Russia is rich in natural resources, it suffers from corruption and no good rule of law. Pakistan has the same problems, plus an even less stable political situation.

Frontier markets, like Kazakhstan, Nigeria and Vietnam, can be even dicier. So investors are probably better off investing in these markets through funds than individual stocks. (For a look at emerging and frontier market funds, see "More Ways to Cross the Frontier.")

FOR MANY INVESTORS, emerging markets are uncharted territories -- or rather they've been charted only by their returns. Last year U.S. mutual-fund investors pumped nearly $96 billion into emerging- market funds, according to EPFR Global. Through July of this year, U.S. investors have pulled $12 billion out of the funds. In the week ending Aug. 10 alone, $7.7 billion was pulled out, the third-largest withdrawal on record.

Even so, emerging-market stocks have returned an average of 4% a year over the past five years, compared with an almost 5% annual decline for developed markets, as measured by the MSCI World Index, which includes the U.S.

Barron's cautioned readers about emerging markets in a cover story last year, warning that the stocks could take a breather after doubling from their 2009 lows ("Taming the Tigers," April 5, 2010). The group pulled back about 15% over the next month before rallying 23% through April 2011. They've since given back almost all those gains. The group is up 2% since our earlier article, while the Standard & Poor's 500 index fell 4.6%.

Among the markets we now like best are Brazil, which trades at less than eight times next year's earnings estimates; China, at 10 times; South Korea, at 7.6; India at 11.5; and Taiwan, at 10.7 (see table).

Where the Buys Are

Emerging markets are cheaper than their developed counterparts with far more growth. Earnings for the MSCI Emerging Markets index are expected to grow at 15% over the long term, versus 12% for MSCI World index.

		Recent	Change			P/E**		2011**
Market	Index	Level	YTD	1-Yr	3-Yr*	2011	2012	Price/Book
Brazil	Bovespa	52,482.82	-23.30%	-21.40%	-0.10%	8.6	7.6	1.2
Comments: Latin America's economic dynamo selling at relatively low valuation.
China	Shanghai	2,534.36	-8.9	-4	5.1	11.7	9.7	1.8
Comments: Concerns of hard-landing for economy could be priced into stocks.
Russia	RTS	1,535.72	-10.5	8.6	-2.4	5	4.7	0.9
Comments: Should benefit if oil stabilizes, and very cheap.
South Korea	Kospi	1,744.88	-9.3	5.6	7.4	8.7	7.6	1.1
Comments: Some analysts expect 2011 GDP to grow a sturdy 5%.
Taiwan	Taiex	7,342.96	-15.1	-3.9	6.7	12.9	10.7	1.5
Comments: Reasonably valued, big commodity exporter.
India	Sensex	16,469.80	-19.7	-9.8	5.4	13.4	11.5	2.4
Comments: One of worst-performing markets this year but GDP still growing strong.
MSCI Emerging Markets		41,204.16	-14.5	-4.6	1.1	12.6	N/A	1.9
Comments: Impressive GDP growth, well-run economy merit premium valuation.
MSCI World		782.98	-12.8	-2.8	-6.5	14.4	N/A	1.8
*Annualzed. **Estimated.			Sources: Bloomberg; MSCI

China, Brazil and South Korea, it bears noting, are among the biggest and most liquid markets in the developing world.

BRAZIL'S BOVESPA is down 23% so far this year, lagging almost every other major global market, on concerns about slowing global growth and appreciation in the real, both of which could be a drag on exports. But there's still much to like about the country: Income is growing, unemployment remains low and the economy is pretty independent of U.S. exports. Exports to the U.S. represent less than 2% of GDP.

And at its current level, the market may already be discounting the worst. Among the more attractive Brazilian stocks is Companhia de Saneamento Basico do Estado de Sao Paulo (SBS), a $5 billion water utility whose American Depository Receipts trade on the New York Stock Exchange. Sabesp posted better-than-expected quarterly results last week. At a recent 51, the ADRs trade at 9.6 times next year's estimates. It could rise to 60.

Stocks in Mexico, the other major Latin American economy, are off 12% this year. Citi expects GDP to grow 4.1% this year, down slightly from 5.4% last year. That's still relatively sturdy but some analysts are underweight Mexico, given its high exposure to the U.S. economy, at 23% of GDP. But there are compelling opportunities in companies that serve the domestic market. The ADRs for Femsa (FMX), Mexico's biggest producer of beer and soft drinks, have gained 36% over the past year, driven by strong growth. That should continue, as the company is expected to benefit from population growth in Latin America. James Hunt, manager of Tocqueville International Value Fund, says the company's stable growth and strong cash flow make it a good bet.

At 66, the ADRs trade at 15 times next year's estimates. Hunt estimates they are worth 80 on a sum-of-the-parts basis.

And while South Korea could go lower on the current panic, the stocks are now attractively priced. Among the most beaten down big names is Samsung (005930.Skorea), which closed Friday at 680,000 won and now trades at 7.5 times this year's estimates. Even with sluggish consumer demand, and problems with its LCD display and TV units, analysts think earnings could grow 19% next year. Smartphone shipments could grow 50% in the next quarter, helping to power the stock up 20% over the next 12 months.

India is priced at a premium to the group, but its economy is growing at a premium rate, as well. The country's middle class is growing rapidly, and some investors think the best way to that is through ICICI Bank (IBN), the nation's largest private-sector bank.

ICICI loans are growing at a 20% clip, and earnings are growing at 30%. But the stock, which closed Friday at 36.60, fetches 15 times earnings. Paul Attwood, of Huntington Global, thinks the stock could rise more than 60% over the next 12 to 18 months.

BCA Research, a Canadian research firm, is generally bearish on emerging markets, citing the waning global recovery. But the firm is overweight Taiwan on the belief that the global tech sector will outperform. The best way to play the country's tech-heavy market is the iShares MSCI Taiwan index ETF (EWT).

The biggest emerging market of them all, China, is down 13% on the year, for all of the reasons stated above and more. But if that country's economy has slowed to "just" 9%, from 10% last year, earnings for China's stock markets are still advancing at more than 15%.

China Mobile (CHL) is the world's largest wireless operator, with more than 600 million subscribers and 70% of the Chinese market -- and it's a compelling play on China's rising middle class. For the year's first half, the company reported an 11% jump in its subscriber count. The stock closed Friday at 48.92 and trades at 10.1 times forward earnings, near the bottom of its five-year range. And it has a juicy 4% dividend, which goes a long way toward taking the risk off in an increasingly risk-off world.