Fund Managers Spy Emerging-Market Bargains

NEW YORK (TheStreet) -- Investors have grown wary of emerging markets.

During the past year, diversified emerging-market funds lost 17.9%, while the S&P 500 gained 1.9%, according to Morningstar.

Part of the problem may be that growth is slowing in some big emerging countries, such as Brazil and China. In addition, investors worry that the crisis in Europe could hurt exports from Asia and Latin America.

But some fund managers argue that the fears are overdone. The bulls say that the earnings outlook for most emerging markets remains favorable, and that the securities look cheap.

Allan Conway, portfolio manager of Schroder Emerging Market Equity(SEMNX) , says that emerging-market stocks trade with a forward price-to-earnings ratio of 9, much less than the P/E of the S&P 500. He estimates that emerging-market earnings should grow 10% this year.

"That's not a bad outlook, especially in a year when you will have a recession in Europe and anemic growth in the U.S.," he says.

Though exporters could suffer from slowing sales to Europe, domestic companies are likely to generate surprisingly strong sales, says Arjun Divecha, portfolio manager of GMO Emerging Countries III(GMCEX) . In a white paper, he predicts that emerging-market consumers will go on a shopping spree in the next several years.

Divecha bases his case on past experience in emerging markets. He says that whenever countries have started to modernize, consumers initially reacted to growing incomes by saving as much as possible.

Families accumulated cash to cover medical emergencies and support elderly relatives. But once per capita GDP reached $3,000 to $10,000, countries began increasing medical services and pensions. In response, consumers raced to buy things that they never had before.

The shift to consumption has been especially dramatic in China. During the past decade, per capita GDP rose from $1,000 to $4,000. In response, auto sales rose from 1 million vehicles a year to more than 17 million.

Divecha says that half of all emerging markets are now in the sweet spot, shifting from saving to consuming.

Domestic sales will also get a boost from demographic changes in countries such as India and Mexico. A record number of young people are entering their earning years. To profit, Divecha suggests investing in such domestic sectors as financials, consumer staples and health care.