Emerging markets are in turmoil, and Canadian stocks have been caught in the downturn. But there’s a buying opportunity here for investors who want exposure to a rebound but don’t like the idea of betting on Turkey and Argentina.
Three Canadian companies stand out for their involvement in emerging markets: Bank of Nova Scotia, Brookfield Infrastructure Partners LP and Hudbay Minerals Inc.
All three stocks have tumbled this year, shadowing a 21-per-cent decline in the MSCI Emerging Markets Index since late January. When emerging markets recover, these domestic stocks should regain their former glory.
Emerging markets are reacting to weaker commodity prices and rising U.S. interest rates. But some are also struggling with specific issues.
Argentina raised interest rates to 60 per cent in response to the deteriorating value of its peso. Turkey, which has veered toward autocracy, is dealing with the ugly combination of a falling lira and loads of U.S.-dollar denominated debt. In Brazil, economic growth is weak. Russia is increasingly isolated because of economic sanctions. And China is engaged in a heated trade dispute with the United States.
If you believe the worst is over, you could bet on emerging markets in anticipation of a rebound – say, through an exchange-traded fund that tracks the entire mix of countries.
Ben Carlson, a money manager who blogs at A Wealth of Common Sense, found that buying emerging market stocks after corrections can be very profitable. The average rebound from a 20-per-cent decline is about 20 per cent in one year and 43 per cent in three years.
The scary part? No one knows whether the downturn has bottomed out.
Here’s where the benefits of investing in Canadian stocks kick in: You get exposure to a rebound in emerging markets without sacrificing Canadian business standards and management expertise.
Bank of Nova Scotia is arguably the safest. The bank has bet big on four developing economies for its international exposure: Mexico, Colombia, Peru and Chile. These countries boast relatively stable economies and open political systems.
Scotiabank has been on an acquisition binge this year, spending $7-billion on additional banking operations. This may be weighing on the stock as investors ponder whether the purchases will pay off. But just as Scotiabank shares suffered the last time emerging markets went into a tailspin, in 2015, they are no doubt suffering from a similar concern today: The stock has underperformed its banking peers by 10 percentage points this year.
But keep in mind that this is an exceptionally profitable Canadian bank, with an attractive dividend yield of 4.5 per cent. While an emerging markets recovery might not make you rich, the downside is limited.
Brookfield Infrastructure Partners (full disclosure: I own units), which invests in global utilities, energy and transportation assets, is also in a rare slump after an 88-per-cent rally from 2016 to the end of 2017. Since December, the shares have retreated 12 per cent.
Rising interest rates are weighing on many stocks that pay dividends – BIP’s yield is 4.8 per cent – as bonds offer meaningful competition for investor dollars.
But more specifically, this is a company with a lot of assets in South America, including natural gas pipelines, toll roads and transmission lines. According to Robert Kwan, an analyst at RBC Dominion Securities, an estimated 30 per cent of BIP’s funds from operations come from the company’s assets in Brazil, where the currency has depreciated as much as 20 per cent this year.
Mr. Kwan sees an upside. “Brazil is a headwind, but we have seen this movie before and it has been a buying opportunity,” he said in a note this week.
He expects the stock price will rise to US$49 within a year (the units trade in New York as well as Toronto). This implies an upside of nearly 25 per cent, not including dividends.
If that’s not enough to tempt you, consider Hudbay. The copper and zinc producer’s share price has wilted 48 per cent this year as investors expect that weaker economic activity among emerging markets will sap China’s appetite for industrial metals, which are also slumping.
But if it’s best to buy commodity producers when they are stone cold, then now is the time. A consensus of analysts expect that Hudbay’s share price will rise 85 per cent within a year. A rebound that strong, of course, will require emerging markets to do their part.