BNY Mellon Asset Investment boutique sees downside to buying emerging markets indexes
A number of macro trends including higher inflation, rising interest rates and vulnerable profit margins have made it more important for investors to focus on valuations in selecting stocks in emerging markets, according to a recent report by The Boston Company Asset Management, part of BNY Mellon Asset Management.
The report concludes that many key emerging markets have passed the stage of the market cycle in which most stocks rise, even though there continues to be strong economic growth across a wide range of emerging markets countries.
"Good economic growth does not necessarily result in a good stock market in an emerging markets country," said Andrea Clark, senior international research analyst at The Boston Company. "For example, consider the strong economic growth, but relatively weak stock market returns in China and Brazil in 2010."
The report cites Chinese economic growth in 2010, when it topped 10 percent. This rapid growth, the report says, raised inflationary fears, which led to tighter monetary policies and highly publicized wage disputes, putting pressure on stocks. The report noted that Brazil and India also faced threats from inflation.
At this stage of the market cycle, The Boston Company recommends that investors construct a portfolio of the most compelling companies in emerging markets instead of buying an index fund or exchange-traded fund (ETF) that buys an entire market.
"Buying an index could cause investors to miss a wealth of stocks that are poised to benefit from local country dynamics," Clark said. "Many of these are smaller companies that are not part of an index, yet are nimble companies strategically positioned to benefit from the next stage of emerging markets expansion, which we believe is tied to the developing middle class in emerging market countries."
The report, reinforcing the importance of stock selection, notes that evaluating margin sustainability, management quality and product resiliency are important factors in determining which companies are best positioned to withstand the pressures of inflation, growing competition and evolving country dynamics.
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