What’s Making Emerging Markets Pop?

According to Bloomberg, “Traders added more than $1 billion to U.S.-traded emerging-market stocks and bond ETFs this month through April 15.”

That puts inflows for the year at $4.5 billion… and it’s a major shift in the markets.
Analysts are saying we’ve passed the low point, and that the rally could continue. But what’s behind this push higher?

#-ad_banner-#The answer is two-fold. First, news out of China is showing some economic stabilization. The country’s GDP growth rate clocked in at 6.7% for the first three month of 2016, and could remain at that level through 2020.

Some folks say this is bad news, as it’s a far cry from the screaming double-digit growth of the last decade. But I say it’s good news, as stable GDP growth in an economy transitioning from developing to advanced is almost unheard of. Many economies in this transition stop growing altogether, or even experience some contraction.

Stable growth from an economy that makes up more than 37% of global GDP? I’ll take that.
And apparently, so will emerging market investors.

The second factor is a stable and recovering U.S. economy. After China, the United States is the world’s second biggest economy, and accounts for 24% of global GDP.

And when these two mammoth economies are stable, the rest of the world can grow.

Think of it this way. Imagine the global economy is a car… a convertible. Now imagine the driver speeding down the road. In the back seat are several friends along for the ride. Suddenly, the car has to make a sharp turn. If the car doesn’t slow down, the force of the turn could roll the whole car, or eject those friends in the back seat.

But if the car slows down enough, it can take the turn and keep its passengers firmly in their seats.

That’s what a developing economy must do if it’s in the driver’s seat. China’s GDP had to slow down, or its transition into an advanced economy would’ve crashed the global economy. China would’ve failed, and brought down the rest of the world with it.

In this scenario, of course, the friends in the back seat are emerging markets.

With a stable China and a recovering U.S. economy, emerging markets are in a rally. Even better, analysts predict there’s more room to grow.

But that doesn’t mean every emerging market is a good place to invest. Some are downright scary. Consider Brazil, which just decided to impeach its president. Or Argentina, with massive economic struggles that it’s only just now starting to address. Not to mention the unstable geopolitical situations in Africa, Eastern Europe and the Middle East.

So, just where should emerging market investors look for an opportunity?

Well, one place to look is Australia and India.

India is going to be the major emerging market story for the next decade. Well-respected economists, including Nobel Prize winner Michael Spence say that India is about 10-12 years behind China’s growth trajectory. That means there’s massive potential in this growth story, with rising middle class demographics set to drive growth in the long-term.

What’s more, the country could sign its first free-trade agreement ever with Australia in the next few months.

What’s interesting about this deal is that Australia has energy and industrial commodities and India has demand. Australia also has services and expertise that Indian businesses could benefit greatly from. This could be a big boon to both sides. In fact, India’s economy is growing at a faster rate than China’s right now, but its trade with Australia is ten times less than Australia’s trade with China.

India is going to be an amazing growth story in the emerging market sector… But with a new trade deal on the horizon, Australia might get a nice economic boost, too.

Risks To Consider: The failure of the trade deal to come to fruition would be a significant drag on both Australia and India. That said, India’s momentum will be somewhat hard to stop, though the economy could get choppy every now and then. Emerging markets in general would slump if China or the United States were to stumble.

But we know that already. Emerging markets are one of the first places to see big losses during economic uncertainty.

So here’s the thing. Yes, investing in emerging markets is risky. The more we can find inevitable shifts, like the demographic shift in India’s middle class, the more sure we can be of a market.

Action To Take: Investors have lots of options when it comes to investing in India, from ADRs to ETFs. In this case, with a free-trade agreement on the horizon, a broad ETF makes the most sense here. The PowerShares India ETF (NYSE: PIN) has diverse holdings, from financial services to technology to energy to consumer cyclicals. It’s a bit more balanced than the Wisdom Tree India Earnings ETF (NYSE: EPI), making it my top choice.

As emerging markets continue their turn around, expect the Indian economy to take the lead.

Editor’s Note: While some global markets are risky for investors right now, it doesn’t mean that there aren’t opportunities. In fact, our colleague Michael Vodicka is finding dividend payers abroad that yield two or three times that of most stocks in the U.S.
To learn more some of the best yields investors can find abroad, click here.