Yahoo Finance Why China's Market Woes Will Hurt Some Emerging Markets
Ouch! China has unleashed a financial typhoon on world markets.
It's true that U.S. stocks got broadly hammered. But the real issue won't be how China's slowing economy affects the U.S. -- because it likely won't.
Rather, the big impact will be felt by emerging market economies that have historically relied heavily on commodity exports, as well as some non-emerging markets that bet big on the materials business.
Some of those developing economies could find themselves in an even worse situation and should be avoided by investors, at least for the time being. Other countries in the complex may be worth a look. Here's what investors need to know.
Emerging markets have already taken a beating. The SPDR S&P Emerging Markets exchange-traded fund (GMM), which tracks the Standard & Poor's Emerging Market BMI index, has fallen more than 20 percent over the past 12 months compared with a dip of around 5 percent for the S&P 500. Both measures exclude dividends.
"All these emerging markets, which levered their economies to the resource industries [such as iron ore or coal], have been caught short," says Steve Blitz, chief economist at brokerage firm ITG Investment Research in New York. "It's going to be a long haul for these nations to figure out a new way to rejig their economies."
With the slowing Chinese economy, Blitz says Beijing has a choice -- either eat up valuable foreign currency reserves defending the yuan, or let it depreciate relative to the U.S. dollar. They'll likely take the later approach.
"As the yuan depreciates, it will lower China's spending power on the world market and will mean that there will be yet further depressing effects on the commodity markets," says Bill Adams, senior international economist at The PNC Financial Services Group. "Depending on how exposed the countries are to the commodity business, there may be market forces that reduce their currency values as well."
For instance, as the yuan falls, the Brazil real will likely need to follow in order to keep its exports competitive on the international market.
Obvious candidates for having their currency crushed more include Argentina, Brazil, Malaysia, Canada and Australia. The last two don't usually get grouped into the emerging markets world, but they both have huge mining and agriculture sectors that have been hurt by the declining prices of commodities over the past few years.
Worse than just falling commodity demand is that emerging markets could see even more so-called capital flight. That's where investors take cash out of a country because they fear that the currency may fall further in value.
"It's typical when U.S. interest rates rise that money that has flowed into emerging markets reverses and comes back to the U.S.," or other developed market money centers, Adams says.
For those countries reliant on commodity exports, "it may be a little early," to start investing, says Jack Ablin, chief investment officer at BMO Private Bank in Chicago.
It's not all bad news for investors. "We have been forced to view emerging markets, not as one single trade, but rather to dig deeper and look for opportunities," Ablin says. A few years ago, it was possible to get richer by throwing money at the broad emerging markets complex, but now it's necessary to pick and choose.
"There are parts of the emerging world that don't hang on every word of Beijing policymakers," he says.
Ablin says that Mexico looks like a bright spot. He sees Mexico benefiting from a new trend in manufacturing, which involves fast delivery and customization of products. Because the Latin American country borders the U.S., it will also benefit from lower shipping costs to American consumers.
India also seems somewhat isolated from the commodity market slump, as it has a diversified economy. Ablin sees Russia as a cheap market with a very cheap currency.
Buy Mexico, India and Russia with ETFs. Investors wish to add some exposure to these markets might want to consider U.S.-listed ETFs that own a basket of stocks.
For Mexico, try the iShares Mexico Capped ETF (EWW). The capped refers to how much weight the portfolio can have in a single stock. EWW holds 53 securities, including telecom company America Movil (AMX) and Fomento Economico Mexicano (FMX) a holding company that distributes products such as Coca-Cola (KO) and Heineken beer. The EWW includes $1.6 billion in assets has an expense ratio of 0.48 percent, of $48 annually for each $10,000 invested.
For India, try the iShares India 50 (INDY) ETF, which tracks the CNX Nifty index of the 50 largest Indian stocks. Top holdings of INDY include tech company Infosys (INFY) and Housing Development Finance Corp., a real estate holding company that trades on the India stock exchange. The INDY is smaller and more expensive than EWW, with $710 million of assets under management and an expense ratio of 0.93 percent.
Investors looking to buy Russia can try the Market Vectors Russia ETF (RSX), which tracks the Market Vectors Russia Index. It should be noted that Russia has a somewhat less transparent judicial system than that of the U.S., which can make investing riskier than at home. The RSX is heavy in energy and basic materials, holding 30 companies, such as gas pipeline giant Gazprom and food retailer Magnit. It has 1.6 billion in assets under management and carries an expense ratio of 0.61 percent.
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