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Don't Fear Emerging Market Stocks

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Emerging market stocks have been seeing record outflow with January seeing outflows this year near $18bln, more than the total of last year. While there is plenty of reason to be concerned reading headlines and market volatility could continue in the near term, this is a good time to look at making Emerging markets more of your portfolio.

Diversification:

Over the past two years the S&P500 has gone up over 30%, in nearly a straight line, while the emerging market index dropped 10%. This no doubt puts your portfolio in an overweight developed market, underweight developing market scenario. This would be a good time to take some off the table in terms of US equities and add some of those gains into developed markets.

Growth:

Adding growth to your portfolio will come up short in any markets. The US is growing at a rate of 3.2% in the 4th quarter over the last, down from the previous quarter. With the recent manufacturing data and Jobs numbers coming out it doesn’t look like growth numbers in the US will rebound in the near term. Europe as a whole is in negative territory in returns of growth and has yet to take any steps to stem the decline. This leave emerging markets to become the growth engine in a portfolio, with lowered estimates still coming in above the US, and debt levels still lower than developed nations as compared to a percentage of GDP, these countries still have room to grow.

Negative sentiment:

Warren buffet said it best, “Be greedy when others are fearful and be fearful when others are greedy”. The negativity around emerging market economies are focused on political unrest, corruption, and capital flight from the end of US quantitative easing (known as tapering). While these are in fact headwinds they should be looked at outside the attention grabbing headlines. While the US had just removed another $10bln a month from quantitative easing (not at $64bln a month) Japan is still contributing $70bln a month in their own easing and could add more if new tax regulations start to slow the economy. Europe, plagued with disinflation, may look to start its own form of easing to bring the region away from a potential deflationary spiral. This will keep liquidity in the markets and stimulate more investment abroad from these regions, despite the US tapering. Politically all of the unrest will cause governments to look at their action during the period of cheap money from QE and make the necessary reforms to have a sustainable economy less reliant on hot money; or face losing re-election.

These factors should be taken into account when looking at investing in emerging markets and the near term volatility will make for good buying opportunities and a good bit of stomach turning and self doubt. But keeping an eye on the fundamental and longer term thinking will prevail. Emerging markets now make up half of world GDP and have a higher growth rate than the developed world. When the global economy does start to pick up it will most likely be sparked by emerging markets and your portfolio should be positions for it.

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