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Emerging Markets or "Submerging" Markets?

Posted by: Ben Steverman on February 13, 2009

Finance ministers from G7 countries, including Treasury Secretary Timothy Geithner, meet today in an effort to steer the world economy toward stability and recovery. But data from around the globe suggests the wild ride will continue.

The swiftness of the global downturn makes it impossible to confidently predict the future. Investors are naturally confused: Is your money better off in the U.S., Europe, Asia? So-called developed markets or emerging markets?

Emerging markets — like China, India, Brazil, Russia and many others — are the toughest puzzle for stock investors. There are reasonable arguments to be made that emerging markets could be the very best place to invest, and there are also good arguments they’re the worst.

Allan Conway, head of emerging market equities at Schroders, gave a talk yesterday on the outlook for emerging markets. He made a good case for the relative attractiveness of emerging markets. Here, according to Conway, are some of the advantages of stocks in emerging markets:

1. No credit crunch or excessive levels of debt in most emerging economies.
2. Economic fundamentals. Because of large reserves, nations like China don’t need to borrow to fund their stimulus packages.
3. It’s not true that China and other countries are unduly reliant on exports to developed nations. Domestic demand has been a big contributor to growth, and so have exports to other emerging nations.
4. Stocks are very cheap in emerging economies.
5. Most global investors, spooked by last fall’s market meltdown, are very much underweight emerging markets. There is money waiting on the sidelines.
6. But the main argument has to do with economic growth:
Conway believes emerging economies will grow 3 to 4 percent faster than developed nations. “This three to four percent growth [advantage] will continue into the future, irrespective of whether this is a recession or depression and how long it lasts,” Conway says.
Even in a worst-case scenario, growth in places like China should remain positive.

But does faster economic growth translate into stock market gains?
Over the last decade it did. From the end of 1998 to 2008, developed stock markets were down about 2%, while the MSCI Emerging Market index rose 143.5%. That takes into account last year’s steep sell-off in emerging market stocks.

Here’s the problem with this sunny outlook:
Even if you accept Conway’s thesis, he admits deciding when markets have finally hit bottom is very difficult. “There are going to be a lot of false dawns,” he says.

Also, Conway admits: In an economic downturn, there is the risk of social unrest in many emerging economies. Slower growth in developed nations will be less disruptive.

Moreover, the fluctuations in the U.S. dollar complicate any American investors’ overseas strategy.

Finally, economists may have a hard time predicting the course of emerging economies over the next few years.

This week, Lombard Street Research’s Charles Dumas issued a much gloomier assessment of China’s economy. He pointed to a 40% decline in China’s imports over the last six months, and a 20% drop in exports. China’s economy could shrink, he warns. “The chance of actual Chinese recession looks major.”

As Conway put it: “It feels like giving a weather forecast in the eye of the storm. Almost any prediction is likely to end up being wrong.”

Long-term fundamentals might look better in emerging economies than those in what Conway calls “submerging” developed economies. But it’s hard for investors to think long-term amid so many present dangers.

Reader Comments

warrent shushi

February 14, 2009 11:28 AM

The recent rally in Chinese stock market looks like a bear market rally. The raising stock prices cover the underlying week economic fundamentals and issues.

harin narula

February 17, 2009 9:24 AM

Conway's thesis makes good sense. Among the emerging BRIC countries China and India should be able to do better compared to Brazil and Russia who are more dependent on commodities which are likely to be sluggish in medium term. Between China and India, China has high reserves and good fiscal position compared to India but may not be able to weather social unrest due to sudden slowdown and loss of jobs as its institutions are weak.India is a more domestic oriented economy and should be able to work its way out of worldwide slowdown notwithstanding its seemingly chaotic politics.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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