2014 will be the year that emerging markets make a comeback. Emerging market stocks, as measured by the iShares MSCI Emerging Market Index ETF (NYSEARCA:EEM), have been drifting lower for nearly three years and are still well below their pre-2008-meltdown highs. Since the second quarter of 2011, emerging markets have trailed the S&P 500 by over 50%. To say that they've been collectively left in the dust would be an understatement.
But while the sector has been largely ignored over the past three years, some real values are emerging. As I wrote recently, when measured against national GDP, most of the largest emerging markets look absurdly cheap and are priced to deliver annual returns well in excess of 15%. By GuruFocus estimates, China is priced to deliver an almost ridiculous 34.3% per year. So, with no more ado, I'm going to offer my five favorite emerging-market country ETFs for 2014.
I'm going to start with a country that will probably make you do a double take: Nigeria. You can get access to Nigerian stocks via the Global X Nigeria Index ETF (NYSEARCA:NGE). I would assume that two questions immediately popped into your mind because they are the same two questions that immediately popped into mine:
- Nigeria has a stock market?
- And it's not a scam asking you to sign your bank account over to the "rightful king of Nigeria" or some such nonsense?
Yes, Nigeria does have a stock market, and no, it's not a scam. Companies engaging in email and fax scams on hapless Americans only comprise about 34% of the index. That was a joke, of course. Nigeria's stock market is full of companies that are well-positioned to profit from the country's burgeoning consumer economy, such as Nigerian Breweries and Nestle Nigeria, a local subsidiary of Swiss confectionery giant Nestle (OTCPK:NSRGY). Financial services represent 40% of the index with energy making up another 26%. Those are higher concentrations than I would ideally like to see, but I don't consider them major negatives.
Why invest in Nigeria? Let's start with growth. From 2005 to 2013, Nigeria has averaged 6.8% GDP growth, making it one of the fastest-growing countries in the world. And the country sailed through the 2008-2009 global crisis with barely a blip. But more broadly speaking, I consider Nigeria part of a larger African growth story. African per capita GDP has more than doubled in the past decade, and according to Deloitte, 7 of the 10 fastest-growing countries in the world are in Africa.
Africa's middle class is already well above 300 million people, or a little more than a third of the population. It's a block of consumers comparable in size to the middle classes of China and India. Looking at valuations, the stocks comprising the index trade at an average P/E ratio of just 11 and an average price/sales ratio of just 0.7. Nigeria is still very much a frontier market. It's at a much earlier stage of development than, say, China, Mexico or Brazil. But I also consider it one of the most promising markets for 2014 and the remainder of the decade.
Continuing the African theme, my next recommendation is South Africa via the iShares MSCI South Africa ETF (NYSEARCA:EZA). South Africa is the largest and most developed economy in sub-Saharan Africa, and it also has the most liquid stock market. South African companies are quietly emerging as regional leaders, taking on established Western competitors. In fact, Western competitors are finding it easier to simply buy out their African competitors rather than slug it out, as was the case in Wal-Mart's (NYSE:WMT) 2012 acquisition of South African mass retailer Massmart.
Being a collection of South African companies, you might expect EZA to be loaded up with gold miners and other resource stocks. Yet basic materials and energy combined only make up about 21% of the portfolio. Nearly 28% is invested in communications, led by regional mobile telecom provider MTN Group (OTCPK:MTNOY), and roughly a quarter of the ETF is invested in the financial sector. Consumer cyclicals chip in another 13%, and health care and consumer defensives add about 7% and 5%, respectively.
If Nigeria is a bridge too far for you, consider South Africa. It is a leading country in a region that I expect to enjoy some of the best growth rates in the world in the decades ahead. Collectively, the countries of Africa represent the last real frontier market left in the world and the only one with the potential to offer "China like" returns.
And speaking of China, I recommend you add China to your list of emerging market ETFs via the DB X-Trackers Harvest CSI 300 China A-Shares ETF (NYSEARCA:ASHR). My bullish case on China is simple enough. The country's recent slowing appears to have bottomed out, and its stock market is almost absurdly cheap. By Financial Times estimates, Chinese stocks trade for just 7.6 times earnings.
Major changes are underway in China. The government has indicated for a few years now that it wants to transform the Chinese economy from an export-and-investment-dependent economy to one that is more focused on domestic Chinese consumers, and it has made this a major objective in its recently-announced Five Year Plan.
It's easy enough to understand why. Chinese consumers have grown accustomed to rising living standards, and the government hopes to channel this sentiment into a booming domestic economy. And while growth is returning to China's main export partners in North America and Europe, the go-go years of the mid-2000s will not be returning any time soon. Meanwhile, with American energy costs in freefall due to the domestic drilling boom, China is finding unexpected competition from manufacturers in the United States. Rising Chinese labor costs only exacerbate this trend.
The most popular China ETF is the iShares China Large-Cap ETF (NYSEARCA:FXI), and it is a fine option for investing in a resurgent China. But my preferred option is the DB X-Trackers Harvest CSI 300 China A-Shares ETF because, unlike the iShares ETF, it invests directly in Chinese A shares, which up until very recently, non-Chinese investors were not allowed to own. The ETF is a little heavier in financials than I would like, at 39% of the portfolio, but this is significantly less than the 53% exposure to financials by FXI. And unlike FXI, which has virtually no exposure to consumer sectors, ASHR has a combined allocation of about 26% to consumer staples and discretionaries.
Next on the list is Turkey via the iShares MSCI Turkey ETF (NYSEARCA:TUR). I've been a big believer in the Turkey macro story for quite some time, and I chose a Turkish stock in InvestorPlace's Best Stocks contest last year (I came in second place, by the way…and within a single point of first).
Turkey bridges the gap between developed Europe and the emerging Middle East. It is simultaneously an emerging market with deep economic integration with Western Europe and the West and an aspiring regional economic power in Eastern Europe and the Middle East.
2013 was a rough year for Turkish stocks. After enjoying a great five-month start, political unrest in May and its close proximity to the Syrian conflict caused investors to sell first and ask questions later. In dollar terms, the Turkish ETF is down nearly 30% from its 2013 highs.
The "taper tantrum" here in the United States didn't help much either. Turkey has a large current account deficit, which means that it depends on portfolio inflows from foreign investors. When the Fed first started making noise about tapering in May, it was as if they yanked the rug out from under all emerging market economies with current account deficits. With the Fed's liquidity spigot closing off, so the thinking went, the hot money that has kept emerging markets afloat will disappear.
At current prices, these risks would seem to be factored in. Turkish stocks trade for just 9 times earnings.
I'm going to cheat a little on the last pick. Singapore is not really an emerging market. It's an emerged market with living standards on par with the West. That said, Singapore is a city-state located at the crossroads of trade between virtually all of the promising emerging markets of South and East Asia, and the country's economy and stock market are closely tied to the same global forces that drive emerging market returns.
You can get access to the Singapore stock market via the iShares MSCI Singapore ETF (NYSEARCA:EWS).
Why Singapore? I like to think of Singapore as a leveraged bet on global trade. The EU is emerging from its worst recession in decades and growth in the United States is starting to accelerate. Add to this a broad-based economic recovery in emerging markets, and you have the pieces in place for a boom in Singapore.
Singapore stocks are also attractively priced. As I wrote recently, Singapore is priced to deliver annual returns of nearly 17%. While I would take that precise number with a grain of salt, if you believe that global trade will enjoy a boom in 2014, then you want to be invested in Singapore.
Disclosure: Long NSRGY, MTNOY, WMT, ASHR, FXI.