Daily Gains Letter

Two Ways to Profit from the Economic Turmoil in Emerging Markets

By for Daily Gains Letter |

Emerging MarketsThe long-expected hit to the emerging markets is finally upon us. The fact that the emerging markets are taking a beating isn’t a total surprise; on the other hand, everyone running for the exits is.

But as physics proves, for every action there’s an equal and opposite reaction—nothing can escape physics; not even Wall Street or the emerging markets.

First, income-starved investors poured money into the emerging markets to take advantage of higher interest rates. Then, after the Federal Reserve said it would begin tapering its bond purchasing program, the money began to pour out of the emerging markets in earnest.

In a nearsighted effort to combat the slide in emerging markets’ currencies, central banks have been raising their interest rates. The Turkish central bank has taken drastic measures to entice investors to return—on January 29 the Turkish government lifted its overnight lending rate from 7.75% to an eye-watering 12% and its overnight borrowing rate from 3.5% to eight percent. The South African central bank raised its interest rate for the first time in almost six years. And the Russian ruble could be next.

This suggests that the underlying danger in the emerging markets isn’t their currencies per se, but the way the central banks are reacting to the slouching currencies. Instead of lowering rates to boost their economies, the central banks have been raising interest rates to prop up currencies.

This could be especially dangerous when you consider that emerging markets make up half of the world’s gross domestic product (GDP). If emerging markets try to follow the U.S. and raise interest rates, it could cripple their own economies (companies would face higher costs, for one). Rising interest rates wouldn’t have the same dramatic effect on the U.S., because the economy is so huge and consumer spending fuels the majority of growth in America.

The fact of the matter is that the economies of many emerging markets are performing better than some of the developed economies and are better-positioned going forward. On top of that, falling currencies would actually be a boon for exports.

So, is it better to consider overvalued stocks balanced on a weak economy, or look at slumping emerging markets that are not as bad off as everyone thinks? While it will take a while for emerging markets’ stocks and exchange-traded funds (ETFs) to rebound from the panicked horror on Wall Street, they should generate solid returns when more rational heads prevail.

To take advantage of the current down climate in the emerging markets, experienced investors may want to consider adding emerging market equities to their portfolio.

Before the dust settles in the emerging markets, investors should have ample time to consider any number of emerging market stocks or ETFs. A few of the more interesting emerging market ETFs that have given up major ground lately include the more general iShares Core MSCI Emerging Market (NYSEArca/IEMG), and the country-specific iShares MSCI Turkey (NYSEArca/TUR) and iShares MSCI South Africa Index (NYSEArca/EZA) ETFs.

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