Double-Barrel Growth for Emerging Markets

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Emerging market stocksand bondshave come blazing back from 2011's slump and should continue to move higher in the next year on the strength of robust economic growth and superior demographics.

The long-term case for investing in emerging markets is based on growing worldwide demand for commoditiesand the expansion of an enormous new middle class in those countries.

That said, the strongest case can be made for those countries with the least reliance on exports and the overall health of the U.S. and euro zone economies.

“The most visible forms of growth are domestic demand consumption in emerging markets,’’ says Stephen Parr, an emerging markets portfolio manager with Aberdeen Asset Management.

Parr sees opportunities in the build-out of infrastructure and telecommunications in countries like India and Turkey. Ultratech, an Indian cement producer, is a key player in the urbanization trend taking over the country.

You can tap Indian stocks through several ETFs, including the WisdomTree India Earnings Index and PowerShares India Portfolio .

In Turkey, Parr favors well-managed construction companies and banks with conservative balance sheets. Financial stocks make up close to half of the iShares MSCI Turkey Investable Market Index . Telecom companies that sell data services like China Mobile are additional plays on the modernization of EM economies.

Consumer demand for services is another theme Aberdeen is tapping through an overweight in consumer staples, energy, healthcare and financial/real estate stocks. Hong Kong real estate developer Hang Lung Group, for example, generates strong cash flow, allowing it to be patient in developing high-end malls that cater to Chinese demand for luxury goods.

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Ingrid Baker, portfolio manager of the Invesco Emerging Markets Equity Fund, looks for well-run EM companies trading at attractive prices. She currently favors stocks in South Africa, which serves as a gateway to demand across the African continent.

Standard Bank has scaled back global expansion to focus exclusively on Africa and is one of the few financial plays on frontier regions like Nigeria. Tiger Brands, which Baker calls the P&G of South Africa, and furniture retailer Steinhoff Internationalare beneficiaries of growing demand for branded goods. The iShares MSCI South Africa Index counts all three stocks among its top 25 holdings.

In addition to South Africa, Baker also likes value stocks in South Korea and Thailand.

While specific sectors including consumer and telecom stocks appear particularly well positioned, macro factors make the EM equity universe as a whole look compelling.

“Valuations are not particularly high, and fundamentals remain excellent,’’ says James Donald, head of emerging markets at Lazard Asset Management. “A lot of companies are doing extremely well, across a great swath of emerging markets.”

Above-average economic growth, low debt levels and positive trade balances provide a strong foundation for EM bonds, especially sovereign and corporate bonds denominated in local currencies.

More companies are tapping domestic markets to finance capital projects, and more EM institutions and investors are demanding local bond exposure, providing strong technical support for the region’s debt markets.

“The superior growth fundamentals offer a chance to earn a higher yield, which makes [EM debt markets] an attractive destination for capital,’’ says Michael Hasenstab, portfolio manager of the Templeton Global Bond Fund.

The ultimate determinant of EM growth is China. Despite the world’s second largest economy lowering its GDPforecast for 2012 to 7.5 percent, market watchers expect growth to pick up in the second half of the year, and say there is plenty of demand left to have a positive, multiplier effect on Asian and South American economies.