Are emerging markets in a comeback?

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Emerging markets have been in the dumps since late 2010 as investors have worried about inflation in countries such as China. But the tide may be turning.

The first piece of evidence is simple price action: The iShares MSCI Emerging Markets Index ( EEM ), a broad measure of the sector, has gained almost 5 percent in the last two weeks while the S&P 500 has barely moved (purple and blue lines on chart below, respectively). That marks a complete reversal of the performance from mid-October through mid-February.

And last Tuesday, as Pete wrote on InsideOptions, our Heat Seeker system spotted a large bullish call spread that's positioning for the fund to rally another 11 percent by April expiration.

We all know that stocks provide a great view into the future, so we often see trends unfolding in the market before they're corroborated in news stories. That appears to be the case with emerging markets now. But I have a few more ideas about what's going on:

--We're returning to a "weak dollar" trend similar to the 2002-2007 period . Despite plenty of evidence that the economy is in recovery, the Federal Reserve is committed to keeping interest rates near zero percent. Meanwhile, other central bankers--including the Europeans--have raised rates or seem willing to do so. Add to that the breakout in oil prices, and things look terrible for the greenback.

--Emerging markets have been in a secular bull market since 2002. The basic factor driving that move is the huge income growth in countries such as China, India, Brazil, Peru. You know, the whole "emerging middle class" mantra. That trend is real, huge, and still pretty reliable--especially because those countries are doing a much better job than the United States at putting citizens to work.

--The sector has been punished long enough. Stocks in long-term booms can spend months or years consolidating before resuming their uptrend. Look at names like Microsoft between 1992 and 1994 and Cisco Systems between 1993 and 1995 for similar examples of this pattern: They made giant moves then stalled, but the fundamentals (in their case, the rise of tech) remained in place. After a period of consolidation, the rallies continued.


Getting back to the recent strength we've seen in emerging-market stocks, one thing that caught my attention was the fact that financials seem to be leading the gains. For example, Peru's Credicorp ( BAP ) is up 9 percent in the last two weeks, and Colombia's Bancolombia ( CIB ) has climbed 11 percent. India's ICICI Bank ( IBN ) moved a little earlier before pulling back but is still up 8 percent in the last month.

EEM vs. SPX These stocks have been in intermediate downtrends and are now contending with resistance at their 50-day moving averages, so investors should watch how they trade in the next few sessions.

Now is the the time to think about getting long. (Something I plan to do.) Financials are good trades because they're a relatively simple way to ride economic growth. More GDP means more money moving around, more credit cards, more bank deposits, and more loans. Another consideration is that most emerging markets deleveraged between 1980 and 2000 at the same time their populations grew. That means more people, but less debt--great news for banks!

As a quick example, consider that BAP's loan book grew at 24 percent in the fourth quarter, more than twice the rate that the economy expanded. IBN and the others are singing a similar tune. (Yes, this will probably result in a U.S.-style debt crash at some point down the road, but that is years or decades away.)

Two other names worth exploring include Brazilian heavyweights Banco Itau ( ITUB ) and Banco Bradesco (BBD). Some other emerging-market stocks outside the financial sector that merit attention include Russia as a whole using the Market Vectors Russia ETF (RSX), which Pete has covered a lot, Russia's Mechel Steel (MTL), and Chinese software company Longtop Financial Technologies, which has gotten beaten down to long-term support despite reporting some terrific numbers on Jan. 31.

Another name I like is China New Borun (BORN), a distillery company that is inexpensive by any metric (forward earnings of five times despite year-over-year net income growing 53 percent). One more is AES, a U.S. company that owns utilities around the world and recently saw some bullish call buying.

Once again, these are just some ideas and please do your own research to be comfortable with your picks. The important thing is that now is the time to start looking--not in three months after they've rallied and everyone is talking about it.

Disclosure: I own BORN shares.

(A version of this article appeared in optionMONSTER's Open Order newsletter of March 9. Chart courtesy of tradeMONSTER.)




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.


This article appears in: Investing , Options

Referenced Stocks: BAP , CIB , EEM , IBN , ITUB

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