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Emerging Markets in the New World Disorder |
Eric Fry, checking in from Laguna Beach, California...
Your Daily Reckoning editors spent most of their waking hours
yesterday traveling from one place to another...and only a small amount of
their time watching the stock market fall.
While Bill Bonner muddied his Gucci loafers in the Andes, Joel Bowman jetted
from Taipei to Sydney and Eric Fry (that's me) completed his reverse-commute
from The Daily Reckoning's headquarters in Baltimore, Maryland to
its outpost in Laguna Beach, California.
Collectively, therefore, your editors spent very little time trying to
determine the "whys" and "wherefores" of yesterday's selloff. But don't be
dismayed; they spent lots of time examining the "whys" and "wherefores" of
yesterday's selloff...in advance of the fact. They've been wondering for
weeks when the long-running rally on Wall Street might finally succumb to
reality.
In other words, the unfolding correction is long overdue.
The economy has never been as robust as the resurgent stock market has been
implying; and the resurgent stock market has never been as fundamentally
valid as CNBC has been declaring. From all outward appearances - and most
inward appearances - the economy still stinks, even though the stench may
have dissipated somewhat. And yet, the S&P 500 Index has soared 60% off the
March lows.
We aren't complaining about this "gift horse," but that doesn't mean we
would stake our retirement on the stud fees this horse would provide. In
fact, we'd imagine that this ol' codger wouldn't survive more than one or
two rolls in the hay. It is not a virile, young stallion. It is a glue
horse. The S&P sells for about 140 times ACTUAL earnings. Sure, next year's
earnings will be better, but probably not good enough to justify current
prices...at least that's our guess.
Happily, US stocks are not the only game in town. In today's column, Chris
Mayer, editor of Mayer's Special Situations, lays out a VERY
compelling case for investing in the emerging markets. The thought is not an
original one, but the rationale is. Please check out Chris' column below...
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The Daily Reckoning
Presents: |
Fresh from his recent sojourn to a couple of major
emerging markets - India and the Middle East - Chris Mayer today offers us
some perspective on the "two horse race" unfolding on the global economic
stage.
How will emerging markets shape up as the power balance levels out
post-crisis...and where can we investors expect to find the ripest
opportunities in the process? Chris provides these details and more below...
Emerging Markets in the New World Disorder
By Chris Mayer
Baltimore, Maryland
In horse racing, a match race is when two horses race against each other.
One of the most famous such races happened at Pimlico, when Seabiscuit beat
War Admiral in November 1938.
In markets, one of the most watched and ongoing match races is the one
between Emerging (or developing) Markets and Developed Markets. The former
include China, India, Brazil and others. The latter include the US, the EU
and Japan. Which one do we bet on and when?
It's a particularly good question now, as we pick through the smoldering
ashes of the 2008 bust. Emerging markets have had a hot 10- year run, even
if you include the crackup in 2008. In fact, even if you had invested in the
MSCI Emerging Markets ETF (NYSE: EEM) on Jan. 1, 2008, you
would be sitting on a profit today. By contrast, the S&P 500 Index has
delivered a double-digit loss over the same timeframe.
The emerging markets have snapped back surprisingly quickly. As Jonathan
Anderson, a UBS strategist put it, "Not even the worst economic crisis in
the postwar era has been able to derail [them]." In financial markets,
ideas, like thoroughbreds, run hot and cold. Past performance doesn't
necessarily decide the issue any more than it does in horse racing. But it
turns out there is a pretty reliable way to handicap the race between
Emerging and Developed Markets.
The "handicapper" in this case is the aforementioned Mr. Anderson, who wrote
about his findings in the Far Eastern Economic Review. His title,
"Emerging Markets Poised to Perform," hints at his conclusion.
It all comes down to those old financial constructs called balance sheets.
In essence, a balance sheet shows you what you own versus what you owe.
These are snapshots in time, a measure of financial health, like an EKG of
one's heart rate. You can often spot trouble here before it becomes fatal.
In my investment services, I always seek out companies with strong balance
sheets - the sorts of companies that own much, but owe little. Enterprises
like theses have the ability to withstand adversity better than those with
weak balance sheets. A strong balance sheet also means that a company can
fund its growth independently and more securely, without having to rely on
fickle lenders.
As investing star, Martin Whitman, wrote in his most recent shareholder
letter: "Don't invest in the common stocks of companies which need
relatively continual access to capital markets, especially credit markets...
Even the strongest, best-quality issuers can be brought down, or almost
brought down, if they continually have to refinance." Unfortunately, many
investors learned this lesson the hard way during last year's severe credit
crisis.
As it turns out, balance sheet strength is also very important for entire
nations. But that's hardly a surprise. Countries that owe a lot of money
tend not to grow as much or as reliably as those with healthy balance
sheets. Anderson created a "stress index" to measure the financial health of
entire nations. A country with high debt levels and deficits earns a high
stress index score. He then plotted this index (inverted) against a rolling
average of GDP growth, a rough measure of economic growth.
Guess what? There's a close connection between the two.
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So one way to explain the growth of emerging markets is to consider the
strength of their balance sheets. When they have healthy balance sheets,
they grow faster than when they have weak balance sheets.
You can see that the last time the emerging markets had a long stretch in
the sun was in the 1960s and 1970s. Emerging markets grew 5% or better. As
Anderson notes, not a single emerging market - not Africa, not even the
Soviet Bloc - failed to post 5% annual growth during this time. And you'll
also note that the balance sheets were healthy.
As a result, emerging markets sailed through the first global oil shock in
1973-75 without much trouble. The developed world, by contrast, suffered the
pain of a deep recession. Investors who stuck with their emerging market
stocks throughout this period reaped big rewards.
According to Anderson, "Between 1965-1980 the dollar-adjusted return on
nascent equity markets in Mexico, Hong Kong, Taiwan, Brazil, South Africa
and other lower-income nations ran into the hundreds of percent - while
indexes in the US and Europe were essentially flat over the same 15-year
period."
Of course, as I say, these things run hot and cold. The emerging markets
"imploded" after the 1980-82 recession. A dozen different countries reported
inflation rates north of 100%. As Anderson points out, 20 currencies lost
50% of their value each year. From 1980-99, emerging markets struggled
mightily and barely grew. And as you see from the chart, their balance
sheets went south as well.
Emerging Market returns during this period were poor overall. A dollar
invested in emerging markets in 1990 was still worth only about a dollar 10
years later. In 2000, though, the game changed again. Emerging markets
opened up. They cleaned up their debts. And the emerging markets went on a
tear that continues today.
In general, emerging markets still have healthy balance sheets today. In
fact, they are as strong as they've been in 50 years. At some point, that
will swing the other way, as these things always do. At some point, there
will be too much debt and too much leverage. But for now, that condition
seems a ways off.
As Anderson concludes, "All the preconditions are in place for a protracted
period of strong economic growth." He guesses 5-6%, which would crush the
Developed World's growth rates. In fact, the superior (and diverging) growth
rates of the Emerging economies are already very visible.
First up, take a look this graph, from The Economist, which shows
the industrial production of emerging Asia compared to the United States.
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Looks like Asia is recovering pretty well. The chart above clearly
illustrates the "decoupling" that became such a hot topic of discussion last
year. The idea was that the Emerging markets would not necessarily follow
lockstep with the Western countries.
The Developed World suffers through what Richard Koo, the chief economist at
Nomura Research in Tokyo, calls a "balance sheet recession." The Western
world suffers from too much debt. That fact shifts the focus from making
profits to repaying debt, according to Koo. Debt repayment will continue
until the West repairs its balance sheets, a process that takes years to
correct, as Japan's long recession shows.
So the same dynamics that make emerging markets look good, work in reverse
for the Developed World. According to Anderson's model, the stressed balance
sheets of the Developed World predict slow growth.
As investors, then, we'll have to continue to look to the emerging markets
for growth. The market never ladles out its rewards evenly, though. To drill
down further, the big winner is really Asia and its big markets of China,
India and Indonesia.
Anderson estimates that these regions could grow 7% or more annually, well
above the tepid rates of developed markets and better than most emerging
markets. "This is a very hefty gap," he writes, "and one that is very likely
to continue to reward investors who take advantage of the opportunity."
Regards,
Chris Mayer,
for The Daily Reckoning
P.S. Right now my publisher is offering you the chance to
try my premium research service, Mayer's Special Situations, for
just $1. At that price, I can't really think of a good reason NOT to try it
but, then again, it's my investment service. In any case, you can take a
look at the
single page offer here.
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continued here. |
