Are Emerging Markets Just Getting Started?

Talking Points

  • Despite recent strength, emerging markets (EM) appear to have room to run.
  • Stable currencies should boost growth.
  • EM economies are diverse and no longer driven by commodities.
  • In our opinion, valuations continue to create opportunities in the near- and long-term.

Enduring Markets

Potential rate hikes in the U.S., tepid growth of developed economies, and a fragile energy market have led to doubts about the staying power of this year’s surge by EM equities. We believe this view overlooks stabilizing local currencies, differentiation among national economies, the long-term potential of developing regions, and continued attractive valuations.

A look at the recent past may explain why some are hesitant to embrace the recent strong returns among EM names.

Much of 2015’s poor performance was tied to weakening local currencies. Among the hardest hit were energy producing countries that faced a one-two punch of lower crude prices and higher debt servicing costs. Brazil highlights the challenge. During 2015, the Real was off more than 45% versus the U.S. dollar. At the same time, oil, the country’s third largest export, remained well below historic averages. The combination was painful for investors with the major Brazilian market down 13.3% in local terms and nearly 42% on a dollar-denominated basis. The country appears to have turned a corner and the free fall has abated even as crude prices remain volatile.

Brazil’s steady currency has been a boon for investors. The Real has firmed and many investors also sense that its Finance Minister has room to step in to quell inflation. The benign situation has led to greater interest in the region and the Bovespa—Brazil’s primary stock exchange—is up 37% in local denomination and 67% in U.S. dollar returns through the first eight months of the year. We believe other emerging countries will continue to benefit from a similar dynamic.

Signs of Firming Currency

Heartland Advisors International Value Investing Portfolio Manager Perspective Currency Chart

Source: SMBC Nikko Securities, Inc., 1/1/2015 to 9/13/16
Emerging Currency Index is proprietary to SMBC Nikko and is compiled from a simple average of standardized values for major emerging currency (start-2010=100).

Stabilization is a growing theme in developing markets and has shown signs of resiliency. As the chart shows, EM currencies weakened significantly in 2015 on fears of U.S. rate tightening. However, when expectations of higher rates ticked up in spring, the reaction was muted. Stronger local currencies can keep inflation in check and provide more flexibility for policy makers to spur growth domestically.

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Heartland Advisors Value Investing Portfolio Manager Robert Sharpe

Robert C. Sharpe

Sharpe is Vice President and Portfolio Manager of the International Value Fund. He has 33 years of industry experience, 4 at Heartland.

Beyond the BRICs

Skeptics of current EM strength note that mature markets are laboring under a low- or no-growth environment. As a result, commodity demand could remain sluggish and upside potential for exporters may be limited. We acknowledge growth in developed markets is tepid, yet believe the strength of local consumers in budding regions is being overlooked. 

Exporters Brazil, Russia, India, and China (BRIC) remain dominant among emerging economies, but opportunities are widespread and less driven by commodity producers. For example, Stock Spirits Group PLC (STCK LN), a leading branded spirits player in Eastern and Central Europe, is a top 10 holding in our portfolio and has been a significant contributor as it has been able to maintain margins in a highly competitive space. The company is indicative of our EM exposure, which is diversified among sectors and lacks direct Energy exposure.

As currency erosion subsides, the chart illustrates how consumers from Thailand to Indonesia are showing early signs of opening their wallets. While the uptick in spending may not make a meaningful impact to economic data, the increased sales can be significant at the company level and should benefit active stock pickers.

Stronger Currency Boosting Sales?

Heartland Advisors International Value Investing Portfolio Manager Perspective Thailand and Indonesia Charts

Source: SMBC Nikko Securities America, Inc., 1/15/2000 to 6/15/2016
Inflation rate is represented by Thailand Consumer Price Index
Source: SMBC Nikko Securities America, Inc., Retails
Sales: 1/15/2004 to 6/15/2016; Inflation Rate:
1/15/2000 to 6/15/2016
Inflation rate is represented by Indonesia Consumer Price Index


Heartland Advisors International Value Investing Portfolio Manager Perspective Thailand ChartSource: SMBC Nikko Securities America, Inc., 1/15/2000 to 6/15/2016
Inflation rate is represented by Thailand Consumer Price Index

Heartland Advisors International Value Investing Portfolio Manager Perspective Indonesia ChartSource: SMBC Nikko Securities America, Inc., Retails Sales: 1/15/2004 to 6/15/2016; Inflation Rate: 1/15/2000 to 6/15/2016
Inflation rate is represented by Indonesia Consumer Price Index

A Long-Term Case

Recent strength aside, we have long been constructive on emerging markets due to a combination of population growth and improved standards of living. In developing economies, the middle class is growing rapidly. 

More young adults are moving to cities, entering the industrial work force, earning higher wages—and enjoying access to an array of consumer goods and services. The world’s middle class population numbered 1.8 billion in 2009.* By 2030, it’s estimated to rise to almost 4.9 billion—a 160% increase in just 21 years.* As this development progresses, the number of middle class consumers will expand dramatically, increasing their share of total global spending. 

The expanded purchasing power of more people earning higher wages can drive growth. This trend is benefiting companies in a number of industries where valuations are reasonable, including automotive, aerospace, and rail stocks. Auto manufacturers and parts suppliers stand to gain as more consumers can afford to purchase cars. In China size and population are creating opportunities for airplane manufacturers, particularly those making aircraft that are suited to the country’s domestic travel market. Similarly, less affluent residents are contributing to stronger rail passenger traffic, and rising volumes of goods being produced and shipped are increasing freight traffic levels.

Selling at a Discount

While we believe the recovery in emerging markets has staying power, for prudent investors, the group only represents an opportunity if stocks are trading at compelling multiples. As the chart shows, valuations are attractive even when adjusted for cyclicality of the business environment.

Emerging Markets: Setting up for a Strong Run?

Source: Copyright 2016, Research Affiliates. Reproduced and republished with permission.  All Rights Reserved, January 1990 to June 2016
**The emerging market Cyclically-Adjusted Price/Earnings (CAPE) ratio is based on the MSCI Emerging Markets Index (prices and earnings in U.S. dollars), which provides earnings data starting in 1995.  Prior to 1995, the MSCI Index data were augmented by data from Global Financial Data (GFD), which reports both total return and price index data for emerging markets. Using this data it is possible to infer the dividend yield for each period that is used, along with the average payout ratio, from the current MSCI data to calculate the earnings per share and CAPE prior to 2005. Details on creating a historical emerging markets index can be found in the Credit Suisse Global Investment Returns Yearbook, 2014.
Economic predictions are based on estimates and are subject to change.
Past performance does not guarantee future results.

Heartland Advisors International Value Investing Portfolio Manager Perspective CAPE Chart

At less than 10x on a cyclically adjusted Price/Earnings ratio, the group is trading at levels not seen since the tech crisis of the early 2000s. The valuations are noteworthy, because in the years following the last time these diminished levels were reached, emerging markets had a sustained run.

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*Kharas, H. (2010), "The Emerging Middle Class in Developing Countries," OECD Development Centre Working Papers, No. 285, OECD Publishing, Paris. DOI:

Past performance does not guarantee future results.

The statements and opinions expressed in the articles or appearances are those of the presenter. Any discussion of investments and investment strategies represents the presenters' views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true.

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Sector and industry classifications as determined by Heartland Advisors may reference data from sources such as FactSet Research Systems, Inc. or the Global Industry Classification Codes (GICS) developed by Standard & Poor’s and Morgan Stanley Capital International.

As of 6/30/2016, Stock Spirits Group PLC represented 3.04% of the International Value Fund’s net adjusted assets.

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