As the U.S. Picks Up Steam, Emerging Markets Still Hold Promise

Markets tend to be maniacal.

The newfound enthusiasm about the outlook for the U.S. economy provides the latest example. In the wake of the financial crisis, some high-profile investors had declared that the U.S. faced years of malaise ahead and that only the emerging world offered near-term prospects for growth.

Capital rushed overseas as money managers marveled at the characteristics -- such as low starting points for income and strong demographic profiles -- that seem to position major emerging markets like Brazil, India and China for heady growth ahead.

But that interest has waned considerably this year as the U.S.'s prospects have improved dramatically.

Overlooking Emerging Potential

"The substantial fund flows into emerging-markets equities over the past couple of years -- nearly $100 billion in 2010 alone -- have now swung in the opposite direction," analysts at Batterymarch Financial Management wrote in a research note this month. "In the last two months, many investors have been taking profits and reallocating assets to developed markets, whose prospects are improving while inflation creates headwinds in the emerging economies."

Many investors may now be overlooking the same emerging-markets growth prospects that they were once so enamored with. And that might open up more opportunities for other investors looking for diversification and growth than were available when those emerging markets were far more popular not long ago.

Take India. When prospects for the developed world looked bleaker, investors focused on the country's strong GDP expansion rate for a democratic country with a large, well-educated, English-speaking population.

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But fears about inflation and a wave of prominent scandals about wireless-spectrum auctions have since taken center stage.

At the start of February, the MSCI India Index had dropped 20% from its high on Nov. 10, Batterymarch Financial Management notes. The fall is even more striking considering that, in the same period, the Standard & Poor's 500 stock index has rallied about 10% in the U.S.

The present, though, may provide a better opportunity for investors to take profits from the U.S. and rotate into India. Valuations are more attractive than they have been, and the country still has plenty of potential for strong underlying growth, even if investors seem to be ignoring it at the moment.

"As 2011 unfolds, India has some difficult weeks ahead as it tries to deal with the challenge of inflation, as well as a modest balance of payments," Jim O'Neill, the head of Goldman Sachs Asset Management, wrote in a note to clients in January. "But, given the power of their underlying story, even if the current moment might not be the absolute best time to be investing, smart policy behavior will allow this remarkable underlying story to unfold."

The Growth Story's Still Booming

How remarkable? O'Neill provided some anecdotes about the growth taking place. IndiGo, a previously little-known Indian airline, recently put in an order for 180 commercial aircraft -- A320 passenger jets, to be exact -- from Airbus. That's the single biggest airline order in history, but IndiGo indicated it's just beginning: The company said it may need 4,000 aircraft over the next 15 years.

An impressive new airport was constructed in not much more than a year, O'Neill wrote, and the Indian Aviation Minister claims that 400 such airports could be built in the future.

This kind of booming growth overseas is leading to a job-creating manufacturing revival here in the U.S. as well. After all, world trade is hardly a zero-sum game. Growth in the U.S. doesn't preclude growth in emerging markets, and vice versa.

But investors looking to tap into the overseas growth may be might better off buying on the emerging-market dips, when the recovery at home is getting all the attention.