This is the time of year when you turn on the television or read a report and every "expert" is giving you their opinion for the upcoming year. I personally do not have a specific investment theme for 2014. My general theme is to be patient, wait for opportunities to present themselves and be ready to pull the trigger when they do. The purpose of this article is to highlight one potential area that I have been allocating funds to over the past two months and has been a common "place to invest in 2014" by many experts, emerging markets.
The television pundits have stated emerging markets as a potential outperformer relative to developed markets because of their underperformance over the past two years. As usual, these pundits suggest being selective as to which countries you invest in. I personally tend to invest in what I have termed the fireman's strategy; I like to run into the burning building while others are running out. This is more commonly known as a contrarian style and is where I begin to generate an overwhelming amount of my investment ideas. This style is often quoted but not often explained why or how it works, so I will take a minute to explain.
It is often said that the rich get richer and the poor get poorer. This is often true when we speak of investments because of the ability of the rich to capture "premiums." By premiums I mean a higher expected return for accepting a greater level of risk. Often we will see premiums for size, company specific risks, leverage, etc… In the case of the contrarian theory we are focusing on the liquidity premium. As a market index or stock tumbles there is a rush to the exit. Those that provide liquidity to the market in the form of buy orders during these times are capturing a liquidity premium, or another way of thinking about it is people are willing to sale at a discounted price. Therefore, the buyer is buying at a discount. On the flip side, when the market or stock comes back into favor people are rushing into buy it, therefore offering a premium. Again, the contrarian investor is offering liquidity to the market through sale orders, thus capturing a liquidity premium on both the entry and exit of the position. The reason this works for the rich is they have the ability to hold the positions. Often individuals panic when a stock or the market goes down because it is a substantial portion of their nest egg and they can not afford to lose it (My personal view is that if you panic and can not afford to lose it you should not be in it to begin with).
I have established a list of countries and indexes that fit the contrarian view for 2014 and will continue to monitor them for entry points. One country I have been focusing on is Turkey.
Turkey has been one of the "darlings" of emerging market investments for a while. The Turkey ETF (TUR) is currently 39% below its fifty-two week high as the country has been hit with a "double" whammy. The first being the anticipation of the reduction in the Feds manipulation of interest rates (aka the taper). The current account deficit has been written about in numerous places so I will not repeat it here. The factor contributing to the drop I will discuss is the savings rate in Turkey. The savings rate is extremely low with various estimates ranging from 11% to 13%. This is not enough to fund investments, thus Turkey is reliant on foreign investments. There has been a tremendous amount of capital outflow in the recent months. I believe this has lead to an over reaction in the market and the decline is over done. However, I only took a small position in Turkey and planned to do add to it after the new year began, but now I will wait as a result of the second event. The second event happened last week and involved the arrest of many prominent individuals on corruption charges. The only comment I have on that event is that I view it as ironic that the probe was orchestrated by a spiritual leader whose network of Muslim believers command a global empire of business, media and education interests. One more ironic point, he lives in Pennsylvania (the individual I'm referring to is Fethullah Gulen).
Other reasons why Turkey has seen a rush to the door is that its GDP declined to 2.2% and that it has specialized in stagnant/declining global sectors. Therefore, individuals are suggesting that Turkey's rise is coming to an end. However, I believe Turkey will still be strong, meaning that it will still see 4-5% growth in the medium term (this is dependent on who is in power after the election). This view is based on Turkey being the sixteenth largest economy, with a large working class population that will not show aging affects until 2025 and low debt to GDP.
Before the recent corruption scandal I was prepared to add to my position in Turkey beginning in the new year. I personally do not invest around holidays because of low volumes. However, because of the scandal I see an opportunity for short-term traders, but recommend proceeding with caution for long-term investments. For the long-term investor (this includes myself), I recommend a time frame of one to five years. I recommend purchasing a relatively small amount of shares at this time (wait for a down day to purchase) and begin to look for entry points between February and April. The ultimate decision to invest a large amount now depends on the elections in March and the markets reaction during this time period. I say this because it is not clear as of yet what the publics opinion of the current regime will be following these allegations, therefore there may be a shift in power. If you believe there will be a bounce back up in the next two months the there is a potential trade using option contracts (the Turkey ETF had a bounce over 5% on Monday followed by a 75bps drop today). I recommend playing this short-term trade using a bull put spread. As of close on 12/31/2013, you could short a February put with a strike price of 47 for $1.25 and purchase a February put with a strike price of 45 for $.80. Your max gain would be $45 a contract with a max loss of $155 or a potential return on capital at risk of 29%.
As always this is before commission because everyone has differing commission rates. Please check your rates before this trade and understand the risk involved before entering the trade.
Other emerging market countries and indexes that I recommend being on your radar for the new year are listed below:
-Chile (ECH): Chile is often thought of as a commodity play and is currently trading 31% below its 52-week high.
-Indonesia (EIDO): Currently trading 38% below its 52-week high.
-Brazil (EWZ): Currently trading 23% below its 52-week high. Look to establish positions should the price drop into the low $41 range.
-Thailand (THD): Currently trading 29% below its 52-week high. Look to establish positions should the price drop back into the low $67 range.
SPDR S&P Emerging Markets Dividend ETF (EDIV): Currently trading 20% below its 52-week high. This is a personal favorite of mine. I continually hold some amount of this fund at all times (or other funds similar to it) and look to add at opportune times.
Guggenheim Frontier Markets ETF (FRN): Currently trading 22% below its 52-week high. This fund is largely focused on Latin American countries. It is a good way to get exposure to Latin America while diversifying.
iShares Latin America 40 ETF (ILF): Currently trading 20% below its 52-week high. The fund is mostly concentrated in Brazil and Mexico which are two of my favorite places to invest. Roughly 70% of the fund is invested in those countries with the remainder in Latin American countries.
Additional disclosure: I have positions in all of the countries mentioned in the article.