The Only Emerging Markets You Should Own Now
For a slew of reasons, Vladimir Putin continues to garner remarkably high approval ratings in Russia, even as he has become a pariah in the rest of the world. Yet one small group of Russians is none too pleased with Putin’s reckless behavior: The Oligarchs.
#-ad_banner-#These Russian billionaires are savvy enough to understand that the imploding Russian economy isn’t simply due to falling oil prices. It’s due to severe economic mismanagement. Billions in invested capital have been wiped out, both in the portfolios of these oligarchs and foreigners unlucky enough to have exposure to this BRIC economy.
You would think that ruinous government policies and an imploding economy would lead even the most stubborn autocrat to come to his senses. In fact, I expected Putin to fold his cards a few months ago suggesting that “after having boxed the Russian economy into a corner, Putin appears ready to alter course.” That was a naive view, though another $25 per barrel drop in oil prices and a subsequent run on the Russian ruble in the past two months didn’t help matters either.
Yet the Putin lesson has been played out time and time again, and as we approach to 2015, it’s a topic worth re-visiting.
The Powerful Appeal Of Emerging Markets
As my colleagues and I have noted on this site many times in recent years, it’s crucial to have exposure to emerging markets. They typically represent robust long-term growth opportunities, far in advance of the likely growth rates that we’ll see in developed economies.
Moreover, for a host of reasons, many emerging markets are extremely inexpensive right now. The last time that foreign markets were so inexpensive, relative to our stock market, was back in 1992, according to a recent analysis by Bloomberg.
What happened next? “The next year, the MSCI ex-U.S. index jumped 30 percent, more than four times the S&P 500’s gain,” wrote Bloomberg’s Lu Wang.
To be sure, emerging markets are long-term investments and not short-term trades. But it’s always wise to buy this asset class when it is deeply out of favor.
Yet investors need to continually track the policies of various governments, eliminating any nations that repeatedly pursue policies that are antithetical to the interests of investors. Vladimir Putin is an obvious example, as are the leaders in Venezuela and Argentina. Yet there are many less obvious examples, and investors need to dig beneath the headlines to understand if a country is a lousy investment, due to poor governance.
Take Thailand as an example. The country posted solid economic growth in the past two decades, but is currently ruled by a military junta that appears ill-equipped to pull the economy out of its current morass. The Thai economy grew just 1.8% in 2013 and slowed further in 2014. Then again, it’s worth tracking events in Thailand, because an eventual reversion back to democracy could lead to a better investment backdrop.
There is one popular way to separate the well-run economies from the poor ones. The Heritage Foundation provides an annual snapshot of economic transparency, in a ranking it calls the “Freedom Index.” Countries that have seen a sharp boost in their economic governance in the past year include:
– Czech Republic
Note that Malaysia and Thailand may seem to have similar economic profiles. Yet Malaysia scores six points higher on this index, which may help explain why the Malaysian economy likely grew around 6% in 2014, even as the Thai economy barely grew.
Perhaps the most radical improvement in governance has come in the western half of South America. Chile, Peru and Colombia have taken a series of ongoing steps to develop more inclusive social policies, create business-friendly investment conditions and as a result, are seeing a major payoff in terms a fast-growing middle class.
Of course these countries are also tied to commodity markets, which has been a recent hindrance. Yet as long as these countries stay on the path of centrist, transparent policies, they represent great buy-and-hold investments. My favorite investments for this region include the iShares MSCI Chile Capped ETF (NYSE: ECH), the iShares MSCI All Peru Capped (NYSE: EPU) and the Global X MSCI Colombia ETF (NYSE: GXG).
Colombia, with a vast trove of natural resources, exemplifies the challenges created by a drop in the price of oil and other commodities, as its market is now at four-year lows. Here’s what this stock chart doesn’t tell you: Colombia is (slowly) making peace with its rebels, its middle class is growing at a steady pace, fueling domestic spending, and it sits on a geographic axis with equally dynamic neighbors, known as the “Andean bloc.” In coming years, commodities will still play a key role in this economy, yet other sectors such as finance, retail, industrial and technology will all comprise a rising share.
Risks To Consider: Never buy an emerging market fund or stock in hopes of a quick profit. Too many variables come into short-term play, such as currency swings, or exogenous shocks, so you need to prepare for lots of volatility on the path to higher valuations.
Action To Take –> Many emerging market investors tend to paint entire regions with a broad brush. Yet even within specific regions, stark differences in terms of governance can have a major impact on investment returns. Malaysia is not the same as Thailand, just as Chile is not the same as Argentina. So make sure your research digs deeply enough to uncover all of the factors that underpin a country’s growth outlook.
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