A high yield can signal one of two scenarios: an impeding dividend cut or a value-priced opportunity.
The high yields on two emerging-market ETFs point to the latter. These ETFs invest in two of the least-liked markets – Russia and Brazil.
No one should be surprised that Russian stocks finished the 2014 in the red. Russia was hit by Western sanctions over its involvement in Ukraine, a depreciating currency, weak energy prices, stagnating economic growth, and rising consumer-price inflation.
Russian stocks have had it rough, though less than you might think when priced in their own currency. The MICEX Index of Russian stocks was down only 2.3% when priced in Russian rubles. The real carnage – from a foreigner’s perspective – is the ruble, which fell 45% in value relative to the dollar last year.
Russia is cheap, very cheap. Russian stocks trade at just six times earnings, on average. Taking a longer view, Russian stocks trade at a 10-year cyclically-adjusted price/earnings ratio (CAPE) of five. To put that in perspective, U.S. stocks trade at a 27 multiple of CAPE.
Market Vectors Russia ETF (NYSE: RSX) is also cheap. RSX is heavily weighted toward energy (43.5%) and financials (11.6%). Both sectors have taken huge hits. But with the hits comes value: Many of RSX’s holdings trade at less than five times current earnings.
The last time Russian stocks traded at such deep values was 1998. In the summer of that year, the Russian economy was staggering under falling productivity, soaring fiscal deficits, and artificially high fixed-exchange rates. By August, Russia’s central bank had no choice but to devalue the ruble and default on its debt. The MICEX collapsed to 20.
Time to panic? Hardly. Less than a year later, in June 1999, the MICEX was trading at 120.
Are Russian stocks set for a similar rebound today? History doesn’t repeat, but as Mark Twain noted, it does rhyme.
RSX is already showing signs of rebounding. Despite the continual stream of negative news, many Russian stocks still make money and still pay dividends. Indeed, RSX paid a $0.66-per-share dividend last month. That payout yields 4.1% yield on RSX’s depressed share price.
Things could get worse in Russia in 2014, or they could get better – a lot better. RSX shares are up already up nearly 10% year to date.
An even higher-yield value investment is found in similarly dysfunctional Brazil. EGShares Brazil Infrastructure ETF (NYSE: BRXX) pays $0.81 per share in dividend. The payout produces a 7.5% yield on BRXX’s depressed share price.
Like Russia, Brazil is perceived as an emerging country. The narrative is incorrect, though. Brazil has been “emerging” for the past 30 years, but has yet to emerge.
It’s more accurate to call Brazil a “cyclical” country. It gets its act together, growth takes hold, and employment swells. Valuations rise to mirror the country’s good fortune.
Then the rug is pulled out. The population elects a utopian socialist who supplants good economic policies with bad. Brazil’s economy and its stock market then cycle downward into a trough.
While languishing in a trough, pressure builds to reengage capitalism. Brazil’s current president, Dilma Rousseff, is reengaging. She has taken one of her biggest political gambles to win back investor trust by cutting $6.7 billion a year in government pension and unemployment benefits. She has also made a series of market-friendly moves. Appointing a free-market Chicago-trained banker, Joaquim Levy, as new finance minister tops the list.
In short, Brazil is being positioned to cycle out of it trough. BRXX should benefit. The ETF holds 30 companies, concentrated on utilities, industrial, basic material, and telecommunications. When the economy grows, so do infrastructure demands.
Russia and Brazil aren’t for the faint of heart. But for investors with staying power and a long-term outlook, they provide exceptional value opportunities.
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