As we jump into the final quarter of 2014, emerging markets are looking much the way they did at the beginning of the year. The popular iShares MSCI Emerging Markets ETF (ARCA:EEM) started the year with a quick 11% drop on, among other things, fears of slowing growth in emerging markets, rising interest rates in the United States and geopolitical concerns across the globe. And as I write this, EEM is in the midst of a brutal month-long correction based on—you guessed it—fears of slowing growing in emerging markets, rising interest rates in the United States and geopolitical risks across the globe.
It’s easy to forget that from the February low to the first week of September, EEM enjoyed a fantastic 24% rally.
Looking at one of my favorite growth markets—South Africa—we see the same story played out. The iShares MSCI South Africa ETF (NYSE:EZA) started the year with a 14% decline only to then rally by a good 31%. But since topping in early September, EZA has quickly dropped 12%.
Trying to call a bottom in any market, let alone volatile emerging markets is a fool’s errand as it depends on investor emotions. I cannot say when investor sentiment will turn. But I can say this. Emerging markets are broadly underowned and inexpensive both based on their own historical valuations and compared to developed markets. And many emerging markets—South Africa included—remain below their pre-crisis highs, at least in dollar terms. EZA, for example, has traded sideways since 2010.
Will emerging markets rally in the fourth quarter? Maybe, maybe not. Only time will tell. But on balance, the right conditions are in place for a rally. The stocks are cheap, sentiment is negative, and the interest rate environment should continue to be benign for at least another six months and probably longer.
MTN Group (OTC:MTNOY), my pick in InvestorPlace’s Best Stocks of 2014, has gotten dragged down by rotten sentiment towards emerging markets. MTNOY stock is down about 14% from its September highs due entirely to perceived macro risks; the company has made no announcements over the past month. At time of writing, we’re still up about 6% for the year, including MTNOY’s impressive 4.6% dividend.
MTNOY’s latest results, for the six months ended June 30, were positive across the board. MTNOY’s subscriber base increased 3.5% to 215 million users, and overall group revenues rose 4.1% in constant currency terms. Data revenues rose by a whopping 33.1% in constant currency terms, and profit margins widened; EBITDA margins rose 3.5% to 46.3%.
Revenue shrank slightly in South Africa due to brutal competition in that market. But MTNOY enjoyed organic, constant-currency growth of 8% in Nigeria, its most important market, and 13.4% on average across its other major African and Middle Eastern markets.
MTNOY is a stock that I believe is uniquely positioned to benefit from the continued rise of Africa’s emerging consumer class. The most critical possession of the new middle class is not the automobile, as it might have been in previous generations, but the mobile phone. And as the dominant African mobile provider, MTNOY is in prime position to benefit from a long cycle of service upgrades as African consumers switch from prepaid to post-paid monthly plans and from basic plans to data-intensive plans.
After the correction of the past month, MTNOY is on sale again. If you don’t already own shares, this is a good time to buy. When sentiment turns on emerging markets in general and South Africa in particular, MTNOY should enjoy a nice “double whammy” of a rising stock in South African rand terms and a rise in the value of the rand itself. For U.S. dollar investors, a return of 50%-100% over the next 12-18 months would seem very reasonable.
Disclosure: Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management.