Two Emerging Markets Set To Outperform
Less than a month ago, a little-noticed event took place in Asia that should catch every investor’s attention: the Vietnamese government gave the green light for an initial public offering of Vietnam Airlines, slated to take place next month. It’s one of many assets that historically were owned by the government. With this announcement, the clock is ticking for a long-awaited program to privatize a range of other government assets.
#-ad_banner-#Vietnam is following the playbook of other emerging markets by letting the private sector have a greater hand in key industries. In the Philippines, for example, a privatization process has been underway for a number of years. Its citizens are now reaping the rewards. According to the International Monetary Fund, the Filipino economy grew 7.2% in 2013 and is expected to grow at a 6.5% pace in both 2014 and 2015.
Vietnam’s economy has also been in growth mode, but has not yet reached its full potential, in large part to still-high levels of government ownership in key industries. Investors have surely taken note. Since late 2010, when iShares MSCI Philippines ETF (Nasdaq: EPHE) was launched, it has outperformed the Market Vectors Vietnam ETF (NYSE: VNM) by roughly 60 percentage points.
To be sure, privatization is not a trouble-free panacea. Studies show that initial benefits tend to only flow to the country’s elite. Yet over time, the process helps attract foreign investment and boost the liquidity of investable assets. Longer-term, as we’ve seen in places like South Korea, robust middle classes take root.
Vietnam and the Philippines share one other crucial trait: They are home to 90 million and 100 million people, respectively. Large populations can form the basis of a sizable consumer class, which is a very important theme for U.S. investors to track. In the Philippines, for example, per capita GDP rose to $2,600 in 2012 from $1,800 in 2009, and is poised to keep rising. Per capita GDP in Vietnam stood at $1,910 in 2013, according to the World Bank, though that figure has also been rising at a rapid pace.
Why should you care about rising incomes? As consumers spend, a range of businesses sprout up to serve them, hiring employees who eventually move up into the middle class, furthering the consumer-spending dynamic. This played out in the United States after World War II, in places like Japan in the 1970’s, South Korea in the 1980’s and China in the 1990’s. History is poised to repeat itself in the next wave of emerging markets, currently known as “frontier markets.”
Vietnam and the Philippines happen to hold especially strong appeal, simply due to their robust populations and a gradual shift towards a more business-friendly set of government policies.
Still, it’s fair to ask, if Vietnam holds such appeal, why has the ETF that tracks its stock market fallen nearly 20% over the past five years?
The answer lies in a series of government missteps. The transition from communism to capitalism has gone remarkably smooth in China, but has been more halting in Vietnam. Also, a lack of infrastructure development led to inflationary bottlenecks in recent years — though inflation has begun to ease in recent quarters.
Equally troublesome, the Vietnamese banking sector accumulated a high level of bad debts, which the government eventually had to take control of. That process has been underway over the past year and, in that time, the Vietnam ETF has managed a 22% rebound, compared to a 15% gain in the S&P 500.
As noted earlier, Vietnam has the ingredients in place — privatization and rising per capita GDP — for a growing middle class. But the country’s export positioning should also get investors’ attention: Vietnam teeters between being the first and second-largest exporter of agricultural products such as rice and coffee and is also building out a large industrial sector. A number of multi-nationals such as Intel (Nasdaq: INTC) have already established operations in Vietnam. As Chinese wages continue to grow at a double-digit pace, more firms are re-locating to Vietnam, which has lower labor costs.
The Philippines share many of those same traits. Agriculture and industrial development are the hallmarks of the economy, while tourism and remittances from expatriates help the country sustain current account surpluses. The country’s GDP growth rate — one of the highest in the world — sets the stage for domestic consumption to become a key driver in the years ahead.
Risks to Consider: China is likely the biggest risk to these countries. China is the top trading partner for every country in Asia, and to paraphrase an old investing maxim, “if China sneezes, Asia catches a cold.”
Action to Take –> Make no mistake, both of these countries still have a considerable amount of tough work ahead before they can reach the economic levels seen in South Korea, Hong Kong and elsewhere in Asia. The key focus for investors is to find such countries in their earlier stages. The South Korean economy, for example, is only growing at a 3% pace these days. If you invest in countries like Vietnam or the Philippines, you need to have a long-term time frame. These countries — and their stock markets — are quite volatile. Their stock markets can fall as quickly as they rise. Yet over the long haul, they possess the perfect ingredients for sustained growth.
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