Investing in Emerging Markets Amid Uncertainty

Global volatility continues to plague the markets. But emerging markets aren't the growth engines they once were.

City at night

The fallout from the June 23 "Brexit" vote that will remove the United Kingdom from the European Union was felt by investors around the world. The S&P 500 Index® fell 5.3 percent in the two days of trading after the vote; the U.K.'s FTSE 250 Index was down 13.6 percent over two days; and in Japan, the Nikkei 225 Index shed 7.9 percent the day after the vote. However, international markets recouped much of those losses in the following days. 

As ramifications for the European Union unfold, Paul Christopher, Head Global Market Strategist, recommends continuing to align asset allocation with long-term investment goals. Being diligent may require frequent rebalancing of assets as volatile markets create risks as well as opportunities.

Emerging markets also struggling
Many investors wonder what may happen to emerging markets as volatility plagues even the strongest developed economies. Even emerging markets such as Brazil, China, and India that previously provided some opportunities are becoming less promising. As the uncertainty from the Brexit vote dissipates, entrenched problems such as bad debt should continue to weigh on stocks in emerging markets such as India and Brazil, according to Christopher, who recently visited India to get a closer look at that country's economy. 

Emerging countries are still mired in excessive debt stemming from the global financial collapse in 2008. In an attempt to protect their local economies from the fallout, banks stepped up financing of new factories, roads, and other infrastructure to spur job creation and spending. Not surprisingly, equity valuations in India and for emerging markets as a whole rose sharply through 2010. Since then, however, tepid global demand for textiles, steel, and other products has hampered trade and hurt profitability of manufacturing firms, leading to defaults on bank loans.

"From an economic perspective, the banks that are stuck with these bad loans that they won't or can't recognize and recover will not be able to lend more money into economies that want to grow," Christopher says. "Better access to credit depends upon the banks solving their bad debt problems."

Corporate earnings in emerging countries have declined since 2014, socking "investors who've become accustomed to those markets gaining value," Christopher says. On the bright side, he says, "We're probably near the bottom of that trend."

"While the near-term outlook is less than rosy, over the long term, Wells Fargo Investment Institute views information technology, health care, and consumer goods as promising sectors in India and other emerging markets." — Paul Christopher, Head Global Market Strategiest, Wells Fargo Investment Institute

Reforms not yet taking hold
Efforts by emerging-market governments to reform financial and legal systems to deal with debt, unequal taxation, and other problems are still in the works, Christopher says.

"We see clear reform paths in India, Brazil, Indonesia, China, and other emerging markets, but we caution that market disappointment over the timing and impact are likely to continue in the coming years," he wrote in a recent report after his India visit.

Due to problems in those economies, Christopher recommends pursuing a broadly diversified approach to emerging markets, limiting exposure for the time being and favoring active equity managers who are selective in their picks over more passive investment vehicles.

Long-term opportunities
"While the near-term outlook is less than rosy, over the long term, Wells Fargo Investment Institute views information technology, health care, and consumer goods as promising sectors in India and other emerging markets," offers Christopher. "Reforms and government initiatives could help these sectors, too." 

For example, the Indian government is fingerprinting one billion people in an effort to improve the financial security of transferring government subsidies to rural consumers, Christopher says. The effort points to the opportunity for investing in companies selling smart phones and those engaged in e-commerce catering to "previously unconnected" people buying goods and services online, says Christopher.

"That's probably one of the most sustainable opportunities we see for U.S. investors going forward," he says. "But it's not quite ready yet" because of unresolved debt problems.

Although the timing of an uptick isn't clear, Christopher says tiptoeing into emerging markets may be beneficial.

"It's probably a good time to start investing if you have no emerging-market exposure or if you are far below your target allocations," he says. "You put a little money in now, and a little more in next quarter, and a little more in the next quarter. In that way, you get to buy in at prices that are low but not necessarily collapsing."

Chris Burritt is a freelance writer in Greensboro, North Carolina, who has written for Bloomberg News.

Image by Thinkstock

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Global Investment Strategy is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this article was prepared by the Global Investment Strategy division of WFII. Opinions represent GIS' opinion as of the date of this article and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this article.

All investing involves risk including the possible loss of principal. Foreign investing presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

This information is provided for educational and illustrative purposes only.

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