There is no polite way to say it: Emerging stock markets have been absolute dogs this year in terms of performance.
At first blush this seems like an odd disconnect, considering the strong growth emerging economies are posting. But the divergence makes more sense when you consider where we are in the global business cycle.
Of course, every dog has its day, and the best investment approach to consider right now may be targeting growth AND income opportunities in faster growing emerging markets.
According to recent economic forecasts compiled by the International Monetary Fund, emerging market economies should expand 5.5 percent in 2013 compared to anemic economic growth of just 2.0 percent and -0.2 percent for the U.S. and Europe, respectively.
But you’d never know it from the lagging returns of emerging market stocks so far this year with many individual markets, including the BRICs, at the very back of the pack in performance …
- Brazil’s Bovespa Index is down 7 percent year to date …
- Stocks in Russia are down 4.8 percent while India has declined 3 percent …
- China’s Shanghai Composite Index of mainland shares is up a paltry 1.6 percent, but Hong Kong shares are down by about the same margin.
Emerging Markets In
Different Phase of Business Cycle
This is a far cry from the S&P 500 performance, notching year-to-date gains of 9.4 percent. But this divergence in actual emerging market performance relative to growth prospects makes it easier to understand when you realize that the emerging world is in a very different phase of the business cycle than developed economies.
While central banks in the U.S., Europe, and Japan are desperately trying to combat deflation with ultra-easy money policies, both India and Brazil have been struggling to reign in persistent inflation. Similarly, China is attempting to cool an overheated real estate sector.
However, performance is an ongoing race with no clear finish line. And quick shifts in relative stock market performance can happen on a dime. A market can lag in performance one quarter, and then suddenly reverse to lead the pack in subsequent quarters.
One of the best leading indicators to spot such a reversal of fortune is to watch the stock market itself.
In the weekly chart above you can see the absolute performance of the iShares Emerging Market ETF (upper panel), as well as its relative performance compared to the S&P 500 Index (lower). EEM has been lagging U.S. stocks for a long time, since 2010 to be exact.
More recently, EEM had the upper hand from mid-2012 until January, but has reversed course since then, falling to new lows recently, down 2.5 percent (in absolute returns) in 2013.
However, there’s more than one way to skin a cat when it comes to emerging market investing. And focusing on emerging market “dogs” is one approach that’s been shooting the lights out in performance!
You’re likely familiar with the Dogs of the Dow strategy. In fact, I wrote about this time honored approach in Money and Markets back in January. The strategy zeros in on the highest dividend yielding stocks among the Dow Jones Industrials … and the dogs have routinely outperformed the Dow 30 over the long-run.
Well, according to research from UBS, a similar approach focused on the top dividend payers among global emerging markets stocks also pays off with consistent outperformance.
By focusing on a select list of 20 of the highest yielding companies in the MSCI Emerging Markets Index, UBS found a compound growth rate of 24.1 percent per year since 2008, which beats the index growth rate of -0.6 percent!
Fortunately, a number of ETF providers are catching on, giving U.S. investors a way to potentially profit from the emerging dogs strategy, without picking and choosing from among hundreds of individual stocks listed on foreign exchanges.
Here’s one ETF to consider: The WisdomTree Emerging Markets Equity Income (DEM) includes high-yielding stocks from over a dozen emerging markets including China, Brazil, Taiwan, South Africa, and Thailand. And DEM pays a sizeable dividend yield of 3.9 percent, well ahead of the Dow’s 2.4 percent dividend yield.
|Dividend paying emerging market stocks pay you to wait for longer term appreciation.|
Another ETF to investigate is the SPDR S&P Emerging Markets Dividend (EDIV). This portfolio is a bit more focused than DEM, featuring 124 stock holdings diversified across similar emerging markets including Brazil, Taiwan, Turkey, and Poland. EDIV offers a slightly higher dividend yield of 5.8 percent.
Bottom line: Investing in high-quality, dividend paying stocks can offer a number of advantages, especially in uncertain markets. First, these are typically more established companies with a long history of earnings growth and dividend payments to shareholders. Second, and perhaps best of all, you earn immediate dividend income upfront, while you wait for longer term capital appreciation.
And this tried-and-true approach appears to work just as well for high-dividend paying emerging market “dogs” as it does for the Dogs of the Dow!