China's economy is slowing down. India's economic reform has stagnated. Europe -- well, it's a mess. Stocks in numerous nations not named the United States have been pounded during the past year. It's easy to see why many investors have decided to sell first, ask questions later when it comes to emerging-market stocks. So it sure seems odd that some of the savviest investors are actually tiptoeing into those stocks.
Crazy? Perhaps. But these managers say there's one big reason they're wading into the likes of Indonesia, Poland and even China: The stocks are dirt cheap. Emerging-market stocks, as a group, are trading well below their historical five-year average of 10 times expected profits. And while those profits may be growing slower than the economies (which are also slowing), analysts say much of that is baked into share prices. "They don't have significant downside," says David Riedel, head of Riedel Research, which specializes in emerging markets.
Investors, fearing a sharp slowdown, have hammered the MSCI Emerging Markets Index down 18 percent in the past year. The so-called BRIC nations (Brazil, Russia, India and China) have fallen even further, by 24 percent. Some fund managers, though, say such declines have given them a chance to pick up stocks cheaply in countries that many analysts agree are in better fiscal health and have faster-growing economies than the U.S. But bumping up the comfort level, analysts say, is how emerging-nation governments are responding to the global slowdown. Unlike policy makers in the U.S. or Europe, those in the emerging world have far more fiscal and monetary ammunition to work with, not having spent as much as developed nations did during the financial crisis and its aftermath. Leaders in China, Brazil and elsewhere are shifting from interest-rate hikes last year to cutting rates and stimulating their economies this year. "Now you have the entire emerging-policy community working on your portfolio bet," says Jim Paulsen, strategist at Wells Capital Management.
And China, for one, now has another advantage over other emerging markets: It's surprisingly cheap. While there's still plenty of debate about just how much that nation's economy is slowing, fund managers are nonetheless hunting for bargains. Jerry Senser, manager of the $1 billion MainStay ICAP International fund, has been focusing on consumer-oriented businesses, such as casinos, entertainment and auto firms, that should benefit from China's growing middle-income population. Some, such as Thornburg Developing World fund manager Lewis Kaufman, have gravitated toward Internet firms. "You would have paid a lot more to access this type of growth before," says Kaufman, adding that Web search firm Baidu was trading at 50 times profits a couple of years ago and now has a P/E of 19.
Other pros, meanwhile, are looking farther afield -- to Poland, for example. Having joined the European Union in 2004, Poland's economy has gone through its growing pains already, and its institutions have been stress-tested, Riedel says. Given that it is not part of the euro, the country has some flexibility and enjoys its role as the back office and low-cost manufacturer for European companies looking for skilled or technical work on the cheap.
Colombia is also increasingly in the spotlight, as consumers and the government boost spending. While not as cheap as other markets, Colombia still trades below its historical average. "With economic growth of about 5 percent, resiliency in earnings and lack of exposure to Europe, it's one of the most interesting markets," says Deborah Velez Medenica, manager of the Alger Emerging Markets fund and a veteran emerging-markets investor.
In recent years, investors have also begun flocking to Indonesia for many of the same reasons they liked India and China in the past -- a large population (the world's fourth-largest), an emerging middle class and improvements in tackling corporate governance issues. Even though it's not one of the cheapest markets, a pressured currency has dragged down valuations of blue chips to about 10 times earnings. "They have seen the doors of hell after their own currency crisis and don't want to go back," Riedel says.
Not everyone is buying the argument, of course. Rattled by China and Europe, investors pulled $1.6 billion out of emerging-market-related stock mutual funds in May, according to Morningstar. But then, such fear is music to the ears of some professional money managers with a long-term horizon -- who, rather than run with the crowd, have been increasing their exposure to emerging markets of late. To be sure, even those who are doubling down caution that such higher-risk stocks could be out of favor for a while. But even so, Citigroup global emerging-markets strategist Geoffrey Dennis expects the group to rise about 20 percent by year's end. Part of such bullishness is because, overall, the world economy will survive this latest crisis. "Once the reality that Europe is going to be standing settles in," says Riedel, "investors will look around and see that there is true value in emerging markets."