Emerging Markets

Friends,

I often use a top-down approach to choose my investments: selecting a sector or region first, and then choosing particular stocks or funds. In that regard, in this post I am proposing to invest a portion of our portfolio in emerging economies.

The following reasons can be considered for this proposal:
• The downside is large: emerging markets are highly volatile; and even worse they may be a bubble that may burst at any moment. But we should not focus only on the downside. The upside is large too: emerging markets have been outperforming the developed ones in the past few years, and it is likely that they continue growing in future. So it should be considered as an investment with high risk and high potential reward.
• Exposure to the emerging markets can help diversify our portfolio. The Canadian market is less than 3% of the word financial market and the US economy is slowing down. But the emerging markets (and the emerging economies) are taking a larger share of the world’s market. For instance, exposure to emerging markets helped Eddie’s and my portfolio recover swiftly during the recent/current financial crisis (would be more difficult without such diversification).
• Underlying economies are healthy. In fact they are often referred to as engines of the world economy; and that they should/may help the US and the rest of the developed economies go though the slow down and avoid a deep recession. “IMF figures show that Asia, not America, has been the main driver of global demand, powering the world economy through its fastest five-year period of growth since the early 1970s.”
• Decoupling! I agree that decoupling may not make sense in the current integrated world (perhaps it is a bad term). But emerging countries are becoming “less” dependent on the US. The percentage of export to the US is decreasing, as trade and “demand” within the emerging countries (e.g. in Asia) increases. “China's exports to America have fallen from 34% of its total exports in 1999 to 25% now”.
• Bubble factor: I am not in a position to judge whether the market in Asia is a bubble or not. But if it is a bubble, it may still continue to grow for years before it bursts. There are many documents arguing that the situation is China for example is still far from what we had in dot com bubble. “The NASDAQ composite index saw a gain of more than 500% from 1995 to early 2000. Japan's Nikkei 225 jumped by 300% from 1984 to 1989. The Shanghai A-share index, having recovered most of its plunge in late May, shows a gain of about only 160% over the past five years. Moreover, Chinese A-shares now have an average price-earnings (p/e) ratio of around 45. At their peaks, the average p/e ratio of the Nikkei 225 in 1989 and the NASDAQ at the start of 2000 were both well over 100.”

Perhaps none of the above is new for any of you. So just consider them as a “collection” of the available arguments in support of investing in emerging markets. I also know that for any of these arguments there are counter arguments. So the decision is up to you. If there is enough interest we can continue discussing the available alternatives, and details. If not we can simply pursue other investment options.

Links to supporting documents:
• America drops, Asia shops: Thanks to the vigour of Asia's consumers, it is a good time for the American economy to slow. http://www.economist.com/opinion/displaystory.cfm?story_id=8057575
• The alternative engine: A sharp slowdown in the American economy could be offset by the growing and largely unrecognised power of Asia's consumers. http://www.economist.com/opinion/displaystory.cfm?story_id=8049652
• The boiling point: How does China's bubble compare with previous financial manias? http://www.economist.com/finance/displaystory.cfm?story_id=9370662
• The great wall of money: China's economy may be less vulnerable to a bursting of the stockmarket bubble than it appears. http://www.economist.com/finance/economicsfocus/PrinterFriendly.cfm?story_id=9225696
• If an economic bubble bursts in China, will anyone notice? http://www.globeinvestor.com/servlet/story/RTGAM.20071024.wibasia24/GIStory/