Where to Invest in Emerging Markets if Fed Cuts Rates

Author: Gary Ashton

Estimated read time: 4 minutes

Publication date: 1st Jul 2019 11:17 GMT+1

The market expects the US central bank (The Fed) to start cutting short-term borrowing costs this year. In previous economic cycles, Fed cuts tended to cause market rallies, especially in emerging markets (EM). Emerging markets benefit from a reduction in US borrowing costs in two stages. The first is a rush to risky EM assets as the Fed lowers the cost of borrowing and the second is a medium to long term ability of EM central banks to reduce their borrowing costs too, which stimulates their economies and stock markets.

In a previous blog (Is It Time to Diversify Away from the US?) I put forward the argument that now may not be the time to abandon US markets, but there are a few emerging markets that could benefit more from a Fed rate cut than others for various reasons outlined below.

Which Emerging Markets Are Best Positioned?

Turkey – Turkey is THE unloved emerging market now. A series of policy mistakes and an overly authoritarian government has taken its toll on Turkey’s equity market. Data from Finscreener.com shows the iShares MSCI Turkey ETF (NASDAQ: TUR) is down 41% in the last three years and trades with a PE ratio of 5.87x. The situation in the country could be poised for improvement, however. Recently the government suffered an electoral defeat in local Istanbul elections that show it is not invincible. Furthermore, the threat of US economic sanctions is waning after a meeting between US and Turkish presidents at the G20 summit in Japan, where the US seems to be giving in to Turkey accepting Russian anti-aircraft missiles. Turkey seems extremely undervalued at these levels.

Russia – If Turkey is the dog of emerging markets, then Russia is the darling. The VanEck Vectors Russia ETF (AMEX: RSX) is up 34.79% in the last three years, according to Finscreener.com and still trades at a relatively cheap PE ratio of 5.82x. Five years of US economic sanctions have damaged Russia less than the market anticipated, and its economy benefits from rising commodity prices such as oil, gas, steel, and diamonds. Foreign investment is still quite low but is improving. Russia ranks 31st in the World Bank Doing Business Ranking, ahead of France, Switzerland, and Japan.

Saudi Arabia – Saudi is a market that is opening to the world after decades of relative isolation. The new crown price has an ambitious agenda to diversify the economy away from oil and launched a program he calls Vision 2030. The plan has already begun to bear fruit with the iShares MSCI Saudi Arabia ETF (AMEX: KSA) up 40.88% in three years according to Finscreener.com. The ETF is relatively expensive with a PE ratio of 17.49x, but it is still early days in the country’s economic transformation.

South Korea – Another country that could be a long-term benefactor to the US / China trade dispute is South Korea, which is an advanced economy with exceptional infrastructure and a robust legal system. Improving relations with its northern neighbour is also an economic benefit. The iShares MSCI South Korea Capped ETF (AMEX: EWY) has been a bit of a laggard, up just 13.12% in three years, according to Finscreener.com, and trades with a PE ratio of 8.93x.

Bottom Line

US Fed interest rate cuts tend to benefit emerging markets globally, but some markets are better positioned to benefit from the next easing cycle. Markets such as Turkey are significantly undervalued and could offer gains for long-term investors with some patience. Other markets like Saudi Arabia are attempting a wholesale reformation of their economy and represent potential long-term investment opportunities. A new US Fed easing cycle could provide an additional boost.


Disclaimer: Gary Ashton is an experienced financial consultant who writes for Finscreener.com. The observations he makes are his own and are not intended as investment or trading advice.