How to Play Emerging Markets With U.S. Stocks
Rachel Koning Beals

Stateside companies that rake in a considerable share of their income in high-growth areas abroad

While the developed world is strapped with heavy debt and an interest-rate policy that has been slow to take hold, emerging markets don't share the same burdens. These budding economies, with their emerging middle class, are increasingly spending on computers, restaurant meals, cars, construction equipment, and other big-ticket items. For investors, increased consumer spending spells opportunity.

Still, because of the volatility and instability often associated with less-mature foreign financial markets as well as potentially undependable and non-standardized financial reporting, investing in stocks through foreign exchanges turns off many U.S. investors.

Another option is investing in U.S. companies that rely on exports -- to Asia, Latin America, and elsewhere -- to boost their bottom lines.

"Without growth from international developed markets, we are left with emerging markets to close the gap. Indeed, recent economic and market trends have provided cause for optimism for the emerging markets," says Christopher Brinn, senior portfolio manager with Key Private Bank, in a commentary. "Future emerging-market growth should help to provide a solid base for improved U.S. exports."

Billions of dollars in economic stimulus looks to be finding greater traction in emerging markets such as China, where aggressive cuts on sales taxes on small automobiles boosted sales earlier this year. Recent data have shown an uptick in Chinese inflation, but the central bank has not yet responded with additional interest-rate hikes; policy steps have instead been aimed at reining in bank lending to deflate a threatening real estate bubble.

China and India are the emerging consumer powerhouses, but 43 other Asian countries are pegged for 7.8 percent economic growth in 2011 and 2012, according to the International Monetary Fund, and their demand for goods could well replicate that seen from the emerging giants.

Investors can still gain exposure to these fast-growing areas of the world by buying shares of U.S.-based and U.S.-traded companies. Machinery, tech, and food companies, in particular, realize a considerable share of their income in higher-growth areas abroad. Although their stocks remain volatile of late, particularly given the wide swings of the U.S. stock market this year, these companies tend to offer more dependable financial accounting and greater liquidity.

There is some cause for caution. Clearly, the overall health of the global economy will impact production and exports. Leading investment banks have recently downgraded their growth projections for the major economies, which could limit emerging-market growth upside to a degree.

In fact, growth in U.S. containerized exports slowed to 6 percent in the second quarter, compared with 12 percent growth in the previous quarter, according to The Journal of Commerce/PIERS research, a trade database and consultancy. The slower growth, including a 2.1 percent year-over-year decline in June, left U.S. export volume up 9 percent in the first half of the year.

High-growth prospects often come with increased volatility risk. But investors should still find ways to bring even a little international flavor to their portfolio, perhaps taking the U.S. angle.

Simon Shnayder, an analyst at investment researcher Value Line, notes some of his preferred picks in a recent commentary:

Pepsico (ticker: PEP) and Coca-Cola (KO) have seen increased market share in China and India where households are accumulating rising discretionary income, a portion of which the population is apparently spending on soft drinks. Unit case volume for Coke products for 2010 over 2009 grew 5 percent in Latin America, 6 percent in the Pacific, and 12 percent in Eurasia and Africa. The companies are investing heavily in production and distribution facilities in these locales. PEP, which offers a 3.4 percent dividend yield, is trading near $60, just off its 52-week low of $59.25. KO, which carries a dividend yield of 3 percent, is trading near $69, in the upper end of its $57.22 to $71.77 52-week range.

Yum! Brands (YUM), parent of the Pizza Hut, Taco Bell, and Kentucky Fried Chicken brands, and McDonalds (MCD) continue their push into emerging markets. China is YUM's largest market now, comprising 42 percent of total revenue. In the second quarter, sales in China surged 33 percent year-over-year as same-store jumped 17 percent. One note of caution here is the pressure from rising commodity costs. In its latest sales report, the Golden Arches' August comparable global sales growth of 3.5 percent missed analysts' calls for 5 percent. YUM is trading near $52, about in the middle of its $44.80 to $57.75 52-week range. MCD is trading near $86, in the upper end of its $72.14 to $91.22 52-week range.

3M (MMM), a diversified manufacturer and technology company with operations in more than 65 countries, has invested abroad and is expanding through both organic growth and acquisitions. The company has a solid capital structure and a 2.9 percent dividend yield. MMM is trading near its 52-week low of $76 and is down nearly 12 percent so far in 2011.

The Dow Chemical Co. (DOW) has been expanding in emerging markets and in its Q2 earnings report hiked its outlook. There is an attractive 3.5 percent dividend yield. The stock trades near $25.75, at the bottom of its 52-week range, though some analysts stress that the price-to-book value remains high.

Two of the bigger tech firms that have already grown an emerging market presence -- and look to continue -- are Intel (INTC), trading near $20.28, about in the middle of its $18.20 to $23.96 52-week range, and International Business Machines (IBM), at $162.42, in the upper end of its $128.43 to $185.63 52-week range.

Several analysts point to Caterpillar (CAT) when thinking of companies positioned to benefit from global construction growth. The world's largest producer of earthmoving equipment sells plenty of machinery to emerging markets and is making more of its equipment in plants operating right in those markets. CAT, which pays a 2.2 percent dividend yield, is drifting in the lower portion of its $70.80 to $116.55 52-week range, last near $83.

Similarly, Deere & Co. (DE), trading near $75, has increased its manufacturing presence directly on Chinese soil. It offers a 2.1 percent dividend yield. Expectations for stronger foreign capital inflows to China due to signs of slowing inflation, is seen as a boon for the cyclical manufacturing sector.

Sector-specific exchange-traded funds (ETFs) can also provide export exposure. They include:

Market Vectors Agribusiness (MOO): Tracks the DAXglobal Agribusiness Index, a benchmark for companies that generate at least half of their revenues in agriculture. The United States is one of the largest exporters of livestock, grains, and other food products to markets around the world. Some 40 percent of MOO's assets are U.S. stocks, with the remainder spread across Canada, Singapore, Switzerland, and other smaller contributors.

Aerospace & Defense (PPA): Offers exposure to companies involved in the development, manufacturing, operations, and support of U.S. defense, homeland security, and aerospace operations, as well as other industrial goods.

Semiconductor HOLDRS (SMH) gives the bulk of its holdings to Intel, Texas Instruments, and Applied Materials, and all three compete well on global markets, standing to benefit from reduced trade barriers that could allow them to better compete with heavily tech-dominant Taiwan and South Korea.

Dow Jones U.S. Pharmaceuticals Index Fund (IHE): With much of the focus of late on U.S. passage of a healthcare reform package that is seen as less-than-favorable to Big Pharma, the industry could find greater overseas opportunities.

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