China's Shanghai Stock Exchange got a few blue-sky days late last month, but whether the financial smog will lift is anybody's guess. Until last October, the SSE was one of the Olympians, rising a bubbly 464 percent in just 30 months. Then it caught the backwash from America's subprime collapse and plunged 44 percent. Most of the rest of the world's emerging markets dropped, too—India, down 48 percent; Russia, down 25 percent, and Brazil, 36 percent. They're fighting inflation and their slingshot growth has eased. To investors, it looks like a no-go zone.
So here's a counterintuitive idea. Put money gradually into e-market mutual funds over the next six to 12 months, says analyst Peter Perkins of BCA Research in Montreal. These stocks aren't optional anymore. Anyone who sees the future has to own them.
That's a tall order for people who remember the Asian financial crises of 1997 and Russia's brush with debt default in 1998. E-markets feel like a playground for crazies, not for someone soberly trying to grow a retirement fund. But these aren't the same economies that went through the wringer a decade ago. They're modernizing countries with growth rates double and triple those of the developed world. As for financial crises, who's got one now? (Hint: it's not Thailand.)
Put aside the idea that developing countries live on the fruits of cheap labor and raw materials. On the contrary, they're home to world-class corporations with innovative management, superior technology and global reach. To mention just three: Embraer, the top small-jet manufacturer (Brazil); Samsung Electronics, a worldwide brand (South Korea), and Infosys Technology, for IT services (India). "The countries in the former Third World will become the dominant economies of tomorrow," says Antoine van Agtmael, president of Emerging Market Management and author of "The Emerging Markets Century."
Right now, these stocks face a wall of worry. Their export markets depend on the health of the global economy and the developed world is slowing down. Also, they lack deep credit markets where businesses can get long-term loans, says Andrew Foster, chief investment officer of the Matthews Asian Funds. India, for one, depends on U.S. capital to grow its ragged infrastructure. When U.S. banks retrench, loans are as hard to get in Bangalore as in Baltimore.
Emerging markets outperformed Standard & Poor's 500 stock average over the past one, three, five and 10 years. It's logical to expect the S&P to be a better play.
When U.S. stocks pick up, however, e-markets typically rise further, faster, says analyst Eric Bjorgen of the Leuthold Group in Minneapolis—as indeed happened when prices bumped up in July. Bjorgen, who's "cautiously optimistic" about U.S. stocks, recently raised his e-markets ante as a play on the S&P. Van Agtmael, who doubted last year's China and India hype, is also in the "early stages of feeling bullish."
That's just timing, of course—gaming a bottom. Strategically, these stocks are here to stay. Most advisers suggest a 5 percent investment in diversified e-market mutual funds or exchange-traded funds. To match e-markets' weight in the world, you'd go to 12 percent.
You may own these stocks without realizing it. Morningstar, the financial-research firm, finds 67 U.S. equity funds that are more than 5 percent invested in e-markets. Among some international funds, that figure exceeds 20 percent. Yes, there's always risk, but today I'd say that the bigger risk is not being there.
P.S. If e-markets are good for geezers, where have the crazies gone? To funds invested in "frontier markets": Nigeria, Kazakhstan, Pakistan, Croatia and the Arab Gulf states. Today, these stocks ride the political winds. In the future, they'll be in our children's IRAs.