Here's Why Emerging Markets Bears Are Wrong

 |  Includes: AND, BBRC, EEM, EWW
by: Emerging Money

By Joseph Hogue CFA

The markets have rebounded from their summer swoon and emerging markets have seen an uptick in fund flows. Enter the perennial bear mantra that growth is over for the developing economies.

Harvard economist Dani Rodrik added a note last week that the impetus behind the rapid growth of the last decade was from increased labor to urban centers from agriculture -- and that this phenomenon is set to slow. Rodrik argues that the manufacturing sector is much more capital intensive, and that higher skill requirements are not attainable for the unskilled labor provided by rural areas.

Rodrik is correct that the labor exodus to the urban centers has slowed for many emerging markets, but their relative urbanization is still well behind that of the developed world.

I think part of the emerging markets skepticism comes from the deceleration in growth we have seen in the BRIC markets. Analysts and the media seem transfixed on Brazil's sub-2% growth and whether China will manage a hard landing.

Overgeneralizing the emerging space through the four BRIC markets is nothing new, but the difference in growth between these markets and the rest of the emerging world is increasing. Southeast Asia has been outperforming, especially Indonesia and Malaysia, while the Andean region of Latin America is still seeing growth around 5% to 6% a year.

Looking to the BRIC nations or the MSCI Emerging Markets Index (NYSEARCA:EEM) for investment opportunities may be an idea past its prime. The BRICs are now within the top ten of the world's largest economies and do not represent the future of emerging markets. Last week we covered the launch of the EGShares Beyond BRICs ETF (NYSEARCA:BBRC) that focuses on the next cohort of emerging markets.

The paper also seems to put too much faith in the typical model of development: from agricultural to industrial, and then to a service economy. Rodrik argues that because manufacturing is not able to absorb the unskilled rural masses, then the transition to a service economy will be slower. The dependence on the traditional model of development is again a generalization.

Latin America followed this route for much of the 20th century but high tariffs and public policy made development emerge in fits and starts. The region has since transitioned to a more service-intensive model with manufacturing employing just 20% of the workforce. Since the transition, the region has seen much more stable growth rates.

I continue to hold a long-term outperform view on Latin America for this reason. Not only will the region benefit from cross-border trade in services but the sector is growing to meet the demands of a rising middle class. The Andean region (Chile, Colombia and Peru) and Mexico continue to be the standouts in Latin America, with Brazil lagging but providing opportunities for speculative positions. Within these, the Global X FTSE Andean (NYSEARCA:AND) and the iShares MSCI Mexico Investable (NYSEARCA:EWW) provide opportunities for exposure. Argentina and Venezuela remain too risky for most investors and should be handled with caution.