The Emerging Markets You Can’t Afford to Ignore

The U.S. economy is seven times larger than Brazil’s economy. Yet the U.S. stock market is 12 times larger. That’s simply the result of the fact that most global investors want exposure to the United States, relatively under-weighting Brazil and other markets in the process.

Now consider this: the Brazilian economy, due to its relatively undeveloped nature compared with the United States, is poised to grow by a faster pace than the U.S. economy in the next 20 years. By some estimates, the U.S. economy will only be three times as large as the Brazilian economy by 2040. In that light, does it still make sense that the U.S. stock market should be 12 times as large?

This isn’t really an article about Brazil. It’s about the many other emerging markets that are currently quite small in relation to the United States, but possess vastly superior growth prospects. Here’s a look at various countries and the value of their stock market in relation to the total world stock market. (Data supplied by Bespoke Investment Group and CIA World Factbook.)

With the exception of China/Hong Kong, every country on this table represents large, established economies that have likely passed their peak growth rates.

Now consider these numbers…

The fact that places like the United Kingdom, Canada and France have larger stock markets than Brazil, India and Russia — even though those countries’ economies are noticeably larger — is surely a lagging indicator. These Western nations are getting credit for where they’ve been during the past century (and the relative maturity and stability of their economies).

#-ad_banner-#But stocks markets should really be a reflection of where economies are headed. And by that score, it’s no contest. These second-tier nations are growing two to three times as fast as the Western economies, and that appears to be a long-term trend.

Let me pose a question. Would you rather own “the U.S. market,” or all of the countries on that second table? Well, all of those countries are still worth just one-third of the U.S. market, even when added together.

Safer than ever
It’s clearly unwise to measure a country’s appeal simply by comparing economy and stock market sizes. The real measure is the perceived safety that these markets represent for investors. The fact that United States and Europe, which have one-eighth of the world’s population but more than 60% of the world’s stock market value, is simply because the emerging markets have proven to be too untrustworthy for most investors.

Yet with each passing year, that paradigm is changing. Countries like Brazil, China, Indonesia, and Turkey are now characterized by much better government, a much more advanced infrastructure, much deeper foreign currency reserves and sustainable domestic consumption. These markets will still slump on occasion, but if you use a five or 10-year time horizon, these economies are actually on more stable footing than the Western economies.

In the past year, I’ve focused on countries like…
— Brazil [Read my original take here.]
— Mexico [and here…]
— India [and here…]
— The CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa) nations [and here…]   

These markets are all performing well in the early part of 2012, not because their economies are growing at an accelerating rate, but because investors have come to see that the crisis in Europe won’t turn into some sort of global contagion.

Risks to Consider: Emerging markets will always be more volatile than more established markets, prone to 30% to 40% annual price swings. Yet over the long haul, these markets represent much more upside than the slower-growing Western economies.

Action to Take –> The emerging market that holds the greatest appeal to you is a function of risk tolerance. Countries like Brazil, Chile and Turkey hold only moderate risk, simply because they already have thriving middle classes and business-friendly investment climates.

Countries like Vietnam, India, Ghana and Indonesia could still stumble on their way to stronger economies, but they are slowly building up a solid foundation. At a minimum, you can take a diversified approach. The MSCI Emerging Markets Index (NYSE: EEM) owns a range of blue chips, from South Korea’s Samsung to Brazil’s Petrobras (NYSE: PBR) to Russia’s Gazprom to Mexico’s America Movil (NYSE: AMX).

The PowerShares Emerging Market Debt Fund (NYSE: PCY) owns the strongest, high-yielding bonds issued by many of these countries. I prefer the SPDR S&P Emerging Markets Small Cap Index Fund (NYSE: EWX) because its portfolio is most closely tied to the dynamic growth of these emerging economies. The point is, choices are no longer an excuse. You simply owe it to yourself to figure which method of exposure to these dynamic regions is best for you.

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