If emerging markets dominate world economic growth, why are emerging-market stocks faring so poorly? This question has bedeviled EM enthusiasts for going on two years now. The popular MSCI Emerging Markets Index ETF (EEM) has underperformed the S&P 500 (^INX) since the summer of 2011. The past six months have been particularly disappointing: Emerging markets stayed basically flat while the S&P surged by 17%.
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Clearly the assumption that economic expansion equals rising equities is not working just now at a macro country level, for whatever reason. But the seemingly logical correlation may still have some validity at a sector level – for instance, with airlines.
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One thing airline stocks can never be accused of is being boring. They are boom-or-bust holdings, highly sensitive to swings in fuel prices and business/consumer sentiment. They had a wretched year globally in 2011, roared back last year as perceptions of crisis eased and traffic rose by 5%, and have bounced around indecisively for most of this year.
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New figures out last week from the International Air Transport Association indicate investors should be feeling bullish about the industry: Worldwide passenger numbers were up another 3.2% year-on-year in April, and 5% when you figure in the anomaly that the heavily traveled Easter holiday fell in March this year. The nuance – no big surprise here – is that virtually all of the growth came from emerging markets.
Middle Eastern aviation is on a tear, growing at a 15% annual clip despite a languishing oil price and the mounting threat of regional war between Sunni and Shiite Muslims. Second in the regional growth charts is Africa, followed by Asia. North America badly trailed all the tigers, eking out a 0.5% gain in April.
Investing on the basis of this market information is not straightforward. Dominant carriers in the Middle East like Emirates and Qatar Airways might be racking up buy orders, except they remain state-owned with no listed shares. The same is true in Africa, where South African Airways is the biggest player.
Asia is a different story, though. Last week researchers at HSBC published a list of half a dozen Asian airline stocks to watch. The hottest among them, Philippines-based Cebu Air Inc. (OTCMKTS:CEBUF) has risen 28% this year. Unfortunately it only trades on the Manila exchange (CEB:PM), which will be a dealbreaker for most US retail investors.
Several of HSBC's picks in China do offer US listings. The peppiest performer lately has been Hong Kong international carrier Cathay Pacific (OTCMKTS:CPCAY). This is an explosive stock. It climbed by 25% last autumn, lost it all back from January to April, but is back to its winning ways for the past two months, rising by 18%. The country's top domestic carrier, China Southern Airlines (ZNH), has struggled this year after a bull run from November to January. But HSBC analysts like its future because it has "the strongest leverage to domestic growth and renminbi appreciation."
Across the globe, a sleeper success story in emerging markets aviation is Panama-based Copa Holdings (CPA), which is turning Panama City into a North-South hub and gaining market share throughout economically buoyant Latin America. Copa shares have been on an uninterrupted roll since September, rising by two-thirds over that nine month span.
But the best bet among "emerging market" airlines so far has been one investors don't need to look up on Google, Lufthansa (DLAKY). Lacking a domestic market in space-challenged Germany, the Frankfurt-based flagship has spent decades building the dominant business between Europe and Asia.
Lufthansa faces stiff new competition from expanding Middle Eastern competitors, and has axed some routes to second-string Eastern destinations like Calcutta and Jakarta. But it has struck back by looking for expansion in Latin America and Africa.
Whatever it is doing, investors clearly approve. Lufthansa has outpaced upstart Copa with a 77% share appreciation since September, and a likeable 111% return over the past year. Shares of its closest rival, Air France-KLM (OTCMKTS:AFLYY), also more than doubled from September-February but then ran out of steam, losing 13% over the past four months.
There are two lessons from this story: First, the best way to buy emerging-markets growth can be through stodgy developed-world companies. Second, while "top-down" emerging-market analysis – handicapping national markets based on GDP statistics economic policy decisions-fails to excite anymore, looking at growth sectors across national boundaries can still yield interesting investment opportunities.