4 Ways to Play a Potential Rally in the Emerging Markets

emerging markets

As did most risk asset classes, emerging markets equity, fixed income and currency markets sold off earlier this year.

The first to be affected was China, which saw price declines since January. By the middle of March all markets had experienced steep selloffs after the health crisis worsened and oil markets collapsed.

The chart shows how Latin American equity indexes have suffered the most. China, in the other hand, had a quick recovery and is trading close to U.S. markets levels for the year.

Currency markets have also suffered. The Brazilian real has lost more than 20% of its value this year, and the Mexican peso about 15%.

Sovereign bond markets have recovered after selling off, but lesser credits such as Argentina and Ecuador defaulted in the last few months. They are well advanced in their debt restructuring efforts.

Four ways to invest

There are four distinct sectors of emerging markets that can be traded by foreign investors, consisting of equities, hard currency bonds, foreign exchange and local bonds.

The risk-reward for each of these sectors is different, and I expect their evolution out of the crisis to diverge.

Three key factors will determine the evolution of emerging markets out of the crisis: The economy at local and global levels, credit markets in each country, and a prevailing low interest rate environment in hard currencies — which will most likely last for a long period of time and provide support to local markets.

Equity markets in Latin America could be posed to regain some ground. The Brazilian equity market iShares MSCI Brazil Index (EWZ) returned 11% in July. It is still more than 30% down for the year.

Under the right conditions it has plenty of room to recover. The country is in the middle of a political crisis, but a fiscal reform is beginning to make its way through its legislature.

The Mexican equity market iShares MSCI Mexico ETF (EWW) is in a similar situation. The links between Mexico and the United States are much stronger.

NAFTA was renegotiated into the new USMCA in 2018. The new treaty was ratified this year in all three participating countries (Canada is also part of the agreement). In the aftermath of the crisis, strong trade ties may resurge, as global production chains get rerouted closer to home for U.S. companies.

Hard currency sovereign bonds have recovered after selling off early in the crisis. The outlook for credit in the corporate sector is negative.

As in the previous oil crisis, the middle ground is in quasi-sovereign bonds, which are corporates partially owned by the government, most notably in the energy sector. Such bonds offer interesting risk rewards and have good upside from current levels.

Investing in them relies in an implicit support by the government, which is not guaranteed to materialize when needed, and some of them might not be able to survive a prolonged crisis on their own.

Foreign exchange and local currency bonds offer some interesting opportunities, mostly driven by the low interest rates environment. They are not as liquid or transparent for individual investors, but with some homework they can be accessed.

Global liquidity

Mexico has a developed local currency market, with sovereign peso bonds trading at above 5%. Brazil is less opened, but some reais-denominated bonds settle in dollars and can be accessed from brokerage accounts in the United States. I expect the yield component of such bonds to decrease on the back of low global interest rates.

Currencies have stabilized in the last few months, but their path remains uncertain in the near term. They will most likely recover once global economic activity is reignited, but until then they face strong headwinds, worsened by fiscal imbalances, and a twin collapse of global supply and demand.

The Federal Reserve has started a swap program with most central banks, providing easy access for U.S. dollars and clearing the way for a stable market during the months ahead, and for U.S. liquidity to become global.

Recommended Articles

FIRE Your Old Financial Life and Retire Early. Here’s How…

A Chicago flight attendant has hit the news for turning her financial life around. At 39, Bianca DiValerio was nearly broke after a divorce and the sale of several failing

Interview: Rates Will Stay Low, Uber ‘to the Moon’

Don't expect the Federal Reserve to even tap on the brakes anytime soon, says Bob Iaccino, editor of the Stock Think Tank. On Thursday, Fed Chairman Jerome threw cold water

3 Crucial Ways to Keep Your Brain Strong Well into Retirement

For people whose whole life has revolved around using their mind, retirement can be a bind. All of those degrees and awards, the presentation notes, the papers, the grand vision

self employed taxes

Help! I’m Self-Employed and My Taxes Are a Mess!

In the not-so-distant past, the word “gig” was used only to describe the work environment for musicians and comedians who would travel from city to city for performances for one

Your Chances of Seeing a Doctor When You Get Sick Are Falling Fast

New studies have emerged that point to a severe shortage of doctors and other vital health workers is on the horizon for the United States. The first report, conducted by the Association

Iaccino: I Took Profits On Bitcoin, but It Has Nowhere to Go But Up

Bitcoin's pull back from recent highs has not dissuaded Stock Think Tank editor Bob Iaccino from owning the cryptocurrency — but he has taken profits. Bitcoin climbed from below $20,000

Facebook Discloses Secret Rules On What Posts Get Blocked — and Why

Ever had a post on Facebook blocked — by Facebook? For the first time, the company is explaining why. The social media giant has now disclosed the once-secret rules on

Iaccino: Buy the Rumors, Sell the Facts On Biden Transition

Bob Iaccino, editor of the Stock Think Tank, says investors should prepare to "buy the rumor and sell the fact" when it comes to plans of the incoming administration of

financial checklist

12 Crucial Money Steps to Take Now for a Better Year Ahead

The beginning of a new year is an ideal time to reset your finances and work towards a more profitable and productive year. Here is a financial checklist with 12

A Simple Strategy to Live Longer by Quitting Work Yet Still ‘Working’

Some see early retirement as the kiss of death, but one study has shown this to be a myth. Retiring early can actually lengthen your life. A 2017 study published in the

deal on new car

Get a Great Deal On a New Car or Truck Using This Tactic

My lease was up on my 2018 vehicle. I was excited to go car shopping. However, what I realized as I ventured out was that the auto industry also has

Renting vs. Buying: What’s Best for Your Retirement?

A white picket fence surrounding a house with 2.4 children, a dog, a cat, a station wagon. This is the American dream. But owning your own home might not be