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Is 2019 The Year Of Emerging Markets?

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Emerging markets are poised to outperform in 2019 but risk-off appetite may cap gains.

Several sell-side analysts have come out in favor of the emerging markets. The emerging markets were hit hard in 2018 as macro-global fears sapped appetite for riskier assets including EM equities and debt Now that headwinds including the US/China trade war are abating those stocks and bonds are trading at attractive levels.

The US/China trade war is the primary cause of global economic slowdown and, now that trade relations are on the mend, investors are asking what comes next. Most emerging markets have strong fundamentals including healthy balance sheets and manageable debt levels so should be able to rebound in 2019.

Because the fundamental picture is so strong some analysts, including those at Lazzard Asset Management, think the EMs could outperform the established markets.

Traders and investors should still expect to see volatility though, at least until trade tensions are resolved anyway. Until that time the global growth outlook may continue to suffer and that will hurt equities across the board, not just in the EMs.

China, developed as it is, still dominates the EM scene but is an investment opportunity in and of itself. There are other emerging markets you should be looking at.

investors US-China trade

Investors looking to buy the iShares Emerging Markets ETF EEM may as well by a China-centric fund it is so heavily weighted in that direction. The only two top-ten holdings that aren’t Asia-ex Japan are a Pennsylvania Closed-End Bond Fund and Reliance Industries, based in India. The top EM ex-China funds are no better, they are nothing more than Asia ex-Japan and China with a small nod in other directions.

Investors looking to target high growth emerging markets should look south of the border. Brazil is the largest and fastest growing economy but it is faced with deceleration and rising inflation so not my top choice. Mexico, another hotbed of activity, is a better choice. Mexico’s economy has been gathering strength over the last year and is now ready to re-accelerate.

The risk in Mexico is two-fold. The first is that government reforms under newly elected President Obrador are going to curb growth in some areas. The second is that the IMF, due in part to those reforms (canceling an airport project), has downgraded Mexico’s GDP outlook for the next two years. The downgrade, from 2.5% and 2.7% to 21.% and 2.2%, is below world average but does not into account the affects of a US/China trade deal.

The upshot to the first risk is that fiscally responsible spending and ending corruption are a net-positive over the long-term. The downside is that, by canceling a project on the brink of commencement, Obrador has lost the trust of potential investors. The question now is if he’ll be able to attract new investments but that may not matter, Mexico’s private sector is growing fast too.

As for the downgrade, the IMF isn’t taking into account the impact of a US/China trade deal and set Mexico up to easily beat the forecast. The deal is becoming more and more likely and will have a profound impact on Mexico’s economy. Mexico does a fair amount of trade with both China and the US, and all three countries are tied together by supply chains, so it is fair to say Mexico would benefit from said deal.

Managers at the Mexico Fund continue to target consumer, industrial, and financial names in order to capture returns. America Movil is the top holding at 14% of the portfolio and also the largest telecommunications provider in Latin America. Other names in the top five include Mexico’s two largest banks, the world’s largest bottler of Coca-Cola outside the US, and Walmart de Mexico. All holdings have operations throughout Latin American which makes the Mexico Fund (MXF) a broader play on the EMs than its name suggests.

The bottom line is simple. There are still some risks in the Emerging Markets but those risks are outweighed by the fundamentals. Now that the end of the US/China trade war is coming in sight global economic activity can re-accelerate. While China is technically the leading EM there are others, including Mexico and greater Latin America, poised to benefit too. Is 2019 the year of the Emerging Markets? It’s too soon to tell for sure but the signs point to yes.