The Fed’s decision to cut the headline U.S. interest rate at the end of October to between 1.5% and 1.75% has been a boon not only for the domestic economy and stocks, but also for emerging markets. The combination of a strong U.S. dollar, weaker commodities sparked by fears of a global recession and the ongoing trade war between the world’s two largest economies China and the U.S. were weighing heavily on many emerging markets. This is because many are dependent on the extraction and export of commodities, notably crude and base metals, to drive economic growth.
News that the U.S. and China are fast approaching a trade agreement coupled with a softer U.S. dollar because of the rate cut and increased optimism over health of the global economy have given emerging markets a healthy lift. MSCI Emerging Markets Index has made some solid gains over the last week to be up by just over 10% since the start of 2019, and there are signs of further gains ahead. This is because greater economic activity and growing confidence have given commodity prices a lift.
Crude has surged sharply to see the international benchmark Brent up by around 23% for the year to date. Base metals such as copper, lead, zinc, and nickel, which are treated as proxies for the health of the global economy, have all also rallied. That will not only lift economic growth but also emerging market currencies, while reducing the fiscal pressures being experienced by many because of a stronger U.S. dollar.
Identifying opportunities
A group of emerging markets that have failed to benefit are those in Latin America, notably the Andean region. MSCI Andean Index, which covers Colombia, Chile, Peru, and Argentina, has lost 11% since the start of 2019. That can be blamed on rising geopolitical risk in Colombia and Chile, which are responsible for 23% and 47% of the index’s country weighting. It has, however, created an opportunity to gain access to some of the region’s fastest-growing economies, which will experience a healthy uptick in growth as demand for commodities soars.
The International Monetary Fund (IMF) in October 2019 forecast that Colombia’s gross domestic product (GDP) for the year will expand by 3.4%, while Peru’s will grow by 2.6% and Chile’s is set to expand by 2.5%. Those growth rates will increase heading into 2020, as geopolitical risk as well as civil unrest subsides and firmer oil as well as base metals prices give their economies a solid boost.
One of the best stocks to gain exposure to those Andean nation’s without leaving the comfort of Canada is Bank of Nova Scotia (TSX:BNS)(NYSE:BNS). Through a series of acquisitions over the last decade, Canada’s most international bank is now the sixth-largest lender in Chile, Colombia’s fifth largest, and the third largest in Peru. For the third quarter 2019, Scotiabank’s international operations were responsible for 47% of its net income on the back of the division’s net income, growing by 20% year over year because of strong loan and deposit growth in Colombia, Chile, Peru and Mexico.
There is a direct correlation between economic growth and demand for loans as well as other financial services, meaning that Scotiabank’s regional earnings will expand as commodities firm and regional geopolitical risk subsides. Firmer regional economies will also lead to lower impaired loans, a reduction in lending loss provisions, and decreased credit write-offs, further boosting operational profitability.
A stronger U.S. economy also bodes well for Canada’s GDP growth, which will drive higher earnings from Scotiabank’s domestic business.
Foolish takeaway
A combination of an improved outlook for Latin America in the wake of the Fed’s rate cut, firmer metals as well as oil prices, growing regional demand for credit and Scotiabank’s strong regional presence will give its earnings a solid lift. That will ultimately translate into a firmer market value. While investors wait for this to occur, they will be rewarded by Scotiabank’s sustainable dividend payment yielding a juicy 4.7%.
