You Can Profit on Bogus Emerging-Markets Fears

NEW YORK (TheStreet) -- You heard me right. Buy emerging market stocks.

Pundits argue that emerging markets are doomed because of the inevitability of rates rising in the U.S. and slowing growth for its largest trading partner, China. These fears are misplaced.

The U.S. credit markets have long been a key access point for emerging market nations' liquidity needs. But rates aren't rising here.

We keep hearing about how rates must go higher as America's economic recovery continues to accelerate, unemployment declines and the Fed draws down its monetary stimulus. But the bond market is already pricing in all of these factors.

Last week, Federal Reserve Chair Janet Yellen announced that the Fed's bond-buying program may be complete by this fall, assuming the Fed will have tapered its Treasury and Mortgage-Backed-Security purchases to zero. She added that six months later, it might make sense to raise the short-term benchmark Fed Funds rate.

The 10-year Treasury was yielding 2.68% the day before Yellen's announcement; it is at 2.67% today. Here is what the iShares Emerging Market Index (EEM) has done versus the S&P 500 since:


EEM Chart
EEM
data by YCharts

Even if rates did gradually move higher from here -- let's say the 10-year Treasury hits 4% -- why is that ominous for emerging markets? The emerging market index more than doubled from 2003 to 2007; the 10-year Treasury stayed between 3.5% and 5.0% over that time period.

EEM Chart

EEM data by YCharts

Just like tapering isn't tightening, slowing isn't shrinking.

We have all seen the warning signs flashing. China is slowing. OK, but what does that really mean? China's GDP grew by 7.7% in 2013. China's economy is still growing three times as fast as the U.S., and their overall output for last year was $9.4 trillion (more than half that of the U.S.'s $17.4 trillion).

So the world's second-largest economy is still growing at the fastest pace, by far, of any of the major economies. Explain to me how that's bad news? The Rule of 72 tells us that China's GDP will double in 9 years -- if we doubt their data or consider that the rate at which they are growing may, in fact, be slowing then maybe it will be more like 10 to 12 years. And China is the country to which the emerging markets export most of their natural resources.

What circumstances make for the best possible pricing of a security? (If you're a buyer, the best pricing is the same as the lowest pricing.) Put simply: When all the news is bad; when you cannot find a single positive catalyst; and when there is no sensible reason for the price to start moving higher. These are indications that a security's price may have bottomed out.

There are reasons to be more selective about which emerging markets you choose -- rather than simply buying the entire index -- but that's a different argument. Emerging market stocks aren't likely to get much cheaper, and just because you aren't hearing about any positive catalysts doesn't mean they don't exist. The two overblown fears above not coming to pass may be the best we'll get.

-- By Adam B. Scott, founder of Argyle Capital Partners, in Los Angeles.

At the time of publication the author was long EEM.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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