By Tim Begany
Many investors have rejected emerging markets, and I can't say I blame them. As a group, emerging markets really went sour in 2011, dropping nearly 19% and trailing the S&P 500's 2% gain by about 21%. Still, I urge those who feel these markets are nothing but bad news to reconsider. After returning 76% in 2009 and 19% in 2010, they were due for a pullback. But now, emerging markets have resumed their upward march, rising more than 14% so far this year, compared with about a 6% gain for the S&P 500.
Now seems an especially good time for investors to jump into emerging markets, because their future once again looks bright. Assuming Europe's debt crisis continues to remain largely at bay, and I believe it will, some economists see emerging markets rising anywhere from 15% to 30% in 2012. Falling interest rates and cheap stock valuations resulting from the 2011 sell-off are among the catalysts that could help propel emerging markets sharply higher, these economists say.
Not all emerging markets have the same growth potential, though. So you might consider putting a portion of the funds you've earmarked for emerging markets into mutual funds or exchange-traded funds (ETFs) devoted specifically to the most promising developing countries.
My favorite emerging market for 2012 and beyond
South Africa may be one of the best places for emerging markets investors. I think its stock market is among those most likely to rise 30% in the coming 12 months. Here's why...
Economically, South Africa is a force to be reckoned with. After expanding at an estimated 3.5% rate in 2011, gross domestic product (GDP) -- now approaching $400 billion annually -- is expected to climb 4.3% in 2012, and growth should average right around 4.2% for the next 10 years, economists predict. In terms of GDP growth, this puts South Africa in same league as some of the more established emerging markets -- like Taiwan, were GPD is projected to rise 4.7% per year, and Brazil, whose economy is expected to grow 4.5% annually. South Africa is a powerhouse compared with some of the more troubled European economies like Italy, which is only projected to grow GDP by only 0.9% a year through 2020.
Although South Africa has long been known for the mining of diamonds, gold and other precious stones, minerals and metals, mining has actually become a progressively smaller portion of the South African economy. And for investors worried about these sometimes-volatile markets, that's a good thing. Mining now accounts for only around 3% of GDP, compared with about 14% during the peak years of the 1980s. Even so, South Africa's mining industry is the world's fifth-largest, behind China, the United States, Australia and Brazil.
Nowadays, agriculture is almost as important to South Africa as mining, accounting for 2.6% of GDP. In fact, South Africa has become a net exporter of agricultural products such as sugar, grapes, citrus fruits, nectarines and wine. South Africa continues to be a popular tourist destination because of its wildlife preserves and diverse culture, and tourism is estimated to account for as much as 3% of GDP.
As you might expect, manufacturing is becoming progressively more important and now generates about 15% of GDP. Auto production, the biggest area of manufacturing, accounts for nearly 8% of GDP. South Africa also has growing telecommunications, banking, e-commerce and retail industries. As a group, South African companies should grow earnings by 16% in 2012, compared with an 11.5% increase for emerging markets overall, analysts estimate.
Another reason to put South Africa at the top of your list of emerging markets to consider: Its economy could be a better defensive play than other emerging economies. This is because corporate earnings are mainly generated domestically, while other emerging markets tend to get their earnings from foreign sources. Plus, the financial system is one of the most efficient and well-regulated in the world, and debt only makes up about a third of GDP (compared with more than 100% of GDP in the United States). Thus, South Africa's economy is better insulated from shocks to the global economy, making it one of the less risky emerging markets in which you can invest.
Risks to Consider: Although South Africa may be relatively less risky, it's still an emerging market and its stock market can be very volatile. There's also no guarantee it will continue to evolve along the lines of current leaders like Brazil and China. High unemployment approaching 25% and other social problems could lead to stagnation and political unrest that derail growth.
Consider including South Africa in your stable of emerging markets investments, both for its solid growth prospects and relative stability. Several diversified ETFs provide plenty of exposure, like Market Vectors Africa (NYSE: AFK), which devotes 28% of assets to South Africa. If you'd like a highly concentrated position in South Africa, look into the iShares MSCI South Africa Index Fund (NYSE: EZA). As its name suggests, this ETF only invests in South Africa. If you're not comfortable with ETFs, have a look at T. Rowe Price Africa & Middle East (Nasdaq: TRAMX), a traditional mutual fund with a 34% stake in South Africa as of Dec. 31, 2011.
Disclosure: Tim Begany does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.