A sharp rebound in emerging markets on Thursday should serve as a wake-up call to investors of opportunities that may exist right now in U.S. industrial stocks and some Canadian manufacturers.
Early Thursday, a much-bigger-than-expected rate increase by Turkey’s central bank helped stem the tide of emerging markets currency-selling; at the same time, separate reports indicated a potential thaw in trade negotiations between the United States and China. The end result was an immediate 1.2-per-cent jump in the broad MSCI Emerging Markets Index.
As the accompanying bottom chart shows, there is a high correlation between the performance of U.S. industrial stocks and emerging-market equities. This suggests investors should be able to own recognizable corporate names while benefiting from a recovery in developing world assets.
UBS economists note that weakness in emerging-market stocks was never really justified by fundamental data, indicating the distinct possibility of a sustainable rally when the bottom is finally reached for asset markets in the developing world.
In a Sept. 10 report, UBS economist Bhanu Baweja wrote that while economic progress in emerging markets wasn’t exciting, “they have seen no tectonic shifts in recent quarters. If anything, they were on a gentle improving trajectory until recently." Relative to developed markets, he wrote, emerging-market equity valuations are currently more attractive than they’ve been for 63 per cent of the postcrisis period.
Mr. Baweja expects volatility to continue in the short term (note that his report was released before the China and Turkey news), but that compelling investment opportunities will be available before year-end. Because of the close relationship between emerging markets and U.S. industrial stocks, this timing on buying globally facing U.S. manufacturing companies should also be considered by Canadian investors.
Morgan Stanley strategist Michael Wilson is bullish on U.S industrials for reasons entirely unrelated to emerging markets. Mr. Wilson believes industrial stocks are attractively valued after a period of underperformance, and that most other U.S. equity sectors are set for earnings disappointments.
“Earnings growth has been strong, but in the case of the industrials sector, this earnings growth has been offset by a nearly 20-per-cent decline in valuation," he said in a recent note. He believes that the sector is now attractively valued to the point “that continued strength in earnings from here can help drive upside.”
For Mr. Wilson, the attractive valuations make industrial stocks a promising risk-conscious investment opportunity.
Morgan Stanley includes eight stock recommendations in the U.S. industrial sector. In alphabetical order, these are Alcoa Corp., American Axle & Manufacturing Inc., Caterpillar Inc., Ford Motor Co., Honeywell International Inc., Knight-Swift Transportation Holdings Inc., Southwest Airlines Co. and United Technologies Corp. (Full disclosure: I own a small position in Honeywell.)
For Canadian markets, my colleague David Berman indicated in a Thursday column three stocks set to benefit from a potential emerging-markets recovery – Bank of Nova Scotia, Brookfield Infrastructure Partners LP and Hudbay Minerals Inc. To that domestic list I’d add Finning International Inc. as the S&P/TSX Composite stock with performance that is most highly correlated to the MSCI Emerging Market Index returns over the past five years. Brookfield Business Partners LP’s units and shares of Russell Metals Inc. rank second and third, respectively, on that list.
Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.
Scott Barlow