My Favorite (Contrarian) Bet on Emerging Markets for 2013

Submitted by Wall St. Daily as part of our contributors program

Please allow me to interrupt the non-stop coverage of the Fiscal Cliff to provide an important reminder.

It’s not all about us!

A whole world of investments exists out there.

Instead of being paralyzed by the historical impasse in Washington D.C. – and the accompanying U.S. stock market volatility – we should be on the lookout for investment opportunities abroad.

Believe it or not, they do exist. And to prove it, today I’m serving one up for you on a silver platter.

So let’s get to it, before it’s too late.

Re-Emerging Emerging Markets

While U.S. stocks understandably suffer from the uncertainty surrounding the Fiscal Cliff, emerging markets stocks are in full-on rally mode.

Consider: Since October, the S&P 500 Index is down 2.9%. Yet the MSCI Emerging Markets Index (MXEF) is up 5.3% over the same period.

The outperformance isn’t a fluke, either. It’s a result of an improving outlook for the global economy, epitomized by the latest reading of the JP Morgan Global Manufacturing Purchasing Managers Index.

In November, the Index checked-in at 49.7, reversing a four-month period of contraction – thanks to expansion in China, Brazil, India, Indonesia, Mexico, Russia, Switzerland, Turkey, the UK and Vietnam.

The upshot? According to a recent research report from Goldman Sachs (GS), now’s a good time to buy emerging markets.

I completely agree. And here’s why I’m dancing Gangnam Style over the opportunity in South Korea…

South Korea: Seven Reasons to Be Bullish

Goldman Sachs’ research revealed a key reality: Emerging markets perform best when the global economy begins to pick up, like it’s doing now.

The research showed that the MSCI Emerging Markets Index rises an average of 3.1% per month when the global economy is growing.

You might think that doesn’t sound too impressive. But just consider that the Index’s average monthly gain during all phases of the economic cycle is a scant 0.7% per month.

So we’re talking about a market that’s on the cusp of rallying more than three times its monthly average.

And historically, South Korea’s stock market is one of the top performers during periods of economic expansion.

That alone is a solid justification to consider investing in South Korea. But here are six more reasons for good measure:

~ It’s All About the Economy, Stupid. South Korea carries the rare distinction of being one of the few economies that was able to avert the global recession. Impressive. But what’s most important is the fact that the world’s eleventh-largest economy is expected to pick up steam in 2013. Barclays Capital expects GDP growth to accelerate to 3.0%, up from 2.2% in 2012.

And while the United States might be able to match that growth in 2013 – and that’s a big “might” – our economy can’t hold a candle to South Korea’s when it comes to employment. At 3%, South Korea’s unemployment rate is among the lowest in the world – a clear indication of the strength of its underlying economy.

To be fair, a strengthening economy doesn’t guarantee a strong equity market. But it certainly helps.

~ Buy High, Sell Higher? Since bottoming out in late July, South Korean stocks are up about 12%. In other words, momentum is on our side.

But don’t be fooled into thinking investors abandoned the old “buy low, sell high” adage in favor of a “buy high, sell higher” motto. Hardly.

Even after the short-term rally, South Korean stocks are anything but expensive…

~ A Bargain By Any Measure. Despite the recent run-up, stocks in South Korea are about 36% cheaper than stocks in the United States. On average, they trade for 9.6 times trailing earnings, compared to 15.1 times for U.S. stocks.

South Korean equities are trading at a discount in relation to emerging markets, too. The MSCI Emerging Markets Index boasts a price-to-earnings (P/E) ratio of 11.3, which is 17% higher than the P/E ratio for South Korean stocks.

If you prefer alternate measures of value, chew on this: Ned Davis Research recently pegged South Korea as the eighth-cheapest emerging market, based on the difference between the country’s earnings yield and its 10-year bond.

So buying into the recent rally actually means we’re buying low, not high.

~ No Fiscal Irresponsibility, Here. While the United States and much of Europe overindulged at the debt buffet, South Korea did not. Public spending only accounts for about 30% of GDP, and the country actually boasts a growing current account surplus.

Corporations are in solid financial shape, too. The days of excessive leverage, evidenced by net debt-to-equity (D/E) ratios of 300%, are long gone. And now the average D/E ratio checks-in below 50%, which means corporate profits are much more stable.

Translation: There’s no risk of a government or corporate debt crisis undermining South Korean stocks. That’s a good thing, because as I shared before, lower risk actually equals higher reward.

~ Promotion, Please. Each June, MSCI reclassifies countries across its family of indices. South Korea is one of only two countries in line for a promotion from “emerging market” status to “developed.”

Barclays’ strategist, Chanik Park, agrees with me that the reclassification could come this year. If so, we can expect more investment capital to flow into the country, boosting equity prices further.

~ An Indirect China Play. The value vultures continue to circle China for signs of a turnaround, which is anything but a sure thing. If you’ve been considering a bet on China, go with South Korea, instead. It represents a low-risk way to benefit from any rebound in Chinese stocks.

How so? Because any growth in China is bound to stir up demand for “raw materials” from South Korea – from steel for auto making to semiconductors for high-end electronics. In other words, South Korea provides two investment opportunities in one.

The Easiest (and Safest) Path to Profits in South Korea

The only drawback to investing in South Korea is that very few companies trade on the major U.S. exchanges. According to the database at The Bank of New York Mellon, there are only nine!

That makes the iShares MSCI South Korea ETF (EWY) our best option. The ETF provides exposure to 105 actively traded South Korean stocks. And at a reasonable price, too. The ETF charges an expense ratio of just 0.59%.

Granted, investing in so many stocks at one time can mute the upside potential. But it also limits the downside risk, which is never a bad thing.

Bottom line: Consider ringing in the New Year with an investment in South Korean stocks. They’re in an uptrend, cheap and still relatively unnoticed by the average investor. In other words, the stage is set for a classic contrarian rally as 2013 unfolds. Don’t miss out!