Emerging Markets A Definite Buy

Jul.27.12 | About: EGShares Emerging (ECON)

The iShares MSCI Emerging Markets ETF (EEM) is down 21% in the last year as the S&P 500 is flat. The major difference in returns is surprising considering the current valuations and the outlook for growth in the next two years. The current P/E ratio for China is 6.8, Russia is 5.3, and Brazil is 10.8, according to the Financial Times. All three are below that of the U.S. and most of Western Europe.

On top of the better valuations is the higher expected growth from the emerging markets when compared to their developed peers. The IMF still believes the emerging markets will grow by 5.6% this year, well above the estimates for the U.S. that are in the 2% range. The Eurozone will be lucky to have any growth this year.

Even with growth estimates cut for some of the major emerging markets, the growth remains robust when compared to the rest of the world. The IMF has cut Brazil and South Africa over the last 15 months to 2.5% and 2.6%, respectively.

The big worry for emerging markets is a decrease in demand for goods from Europe and less credit flowing their way from the same region. The European Union is the largest purchaser of goods from emerging markets. The region buys 19% of China's exports and 22% from South Africa.

How to Play the Emerging Markets

There are two ways to play the emerging markets if you agree with me that the region is at attractive levels. The first would be to buy into the entire region via an ETF such as EEM. This approach would have the highest correlation to the situation in Europe and the global economy because the majority of the stocks in the ETF are international large-caps.

The more interesting option with less exposure to the outside world would be investing in niche emerging market ETFs. An example would be the EG Shares Emerging Markets Consumer ETF (ECON). The ETF focuses on stocks based in the emerging markets that generate a large portion of their revenue from local consumers. Because the companies in the ETF are better positioned to weather a global slowdown I feel it would offer a better reward-to-risk option for long-term investors. There is also the fact I feel the middle class will continue to emerge in the emerging markets helping boost such an ETF.

Disclosure: I am long ECON.