The Future Trends of Emerging Markets

Perhaps rather it was a natural consequence of the modern portfolio theory taught in the United States, to diversify and take higher risks, coming on the back of what wsa then a ten-year-old bull market. From the developing countries' position, private investors were offering capital at no annual interest rate (we called it equity; they called it free, without management strings), which was more attractive than bank or government lending. It was a meeting of lovers and there was a love fest. And now, they have matured with all of the obligations and responsibility that come from the next age level.

Mobius selects the largest countries as the ones with best future potential presumably for the attractiveness of their domestic markets. The first rush of emerging markets was for export sales and that is now over. He is right to emphasize places like Nigeria and Egypt. And he is right in the sense that if he is wrong, these overpopulated countries will not tolerate a world with such huge disparities of communications and living standards.

But before we get to 2010, we must deal with the traumas of the late 1990s. Since the beginning of the Asian crisis in July 1997, there has been an approximately 50% decline in emerging markets. It started in Asia, became most visible and most illustrative in Russia, with about a 90% decline, approximately the same as in Indonesia, the fourth largest country in the world in terms of population. And pressure built up in Latin America.
rates, in higher markets, to take them out. And even if not at higher levels, they take them out anyway because emerging markets on the whole look like a considerably less attractive place to invest than they did five years ago. This is a world-wide phenomenon, not just limited to Indonesia, Russia and Latin America.

What is it all about? The mixture of rising nationalism and deflation is very potent negative medicine for emerging markets. Reform of banking systems means banks have to recognize bad loans. Interconnectivity means that when something happens in one part of the world, the rest of us all feel it. This is not necessarily a dramatic buying opportunity except for those people who can watch the hourly news. And yet, we are setting up the conditions by which the long struggle of the workout period can take place. It is probably some distance into the future, but the early dramatic decline has certainly been felt.

In the meantime, there will be continual turmoil in these countries, promoting more nationalism, more separation from the international community and yet more necessity on the part of the developed nations, especially the United States, to support them.

China may be different in the sense that it has a high surplus of dollars with its very positive trade balance with the United States, and it may come out of this phase as the dominant emerging market. Mobius is right about the necessity for structural reform but this country seems destined to dominate its region and possibly to be the next sole superpower. It is a tremendously powerful force in the region and in the world, and the group that is running China now and in the next decade is very competent. We should pay careful attention to them.

Meanwhile, the United States itself looks increasingly like an emerging market. As with most emerging markets, it depends entirely on an inflow from outside its own borders in order to survive. There is a negative savings rate, and debt cannot be liquidated on its own but only rolled over, a characteristic of an emerging market. And it is very much an overbought emerging market having extended a very great boom for essentially the last 18 years. But more than that, the United States is an emerging market that has turned over its financial responsibility to the rest of the world. The degree to which the country borrows in dollars is helpful. But the degree to which dollars are held by foreigners is harmful since foreigners can start liquidating those dollars in order to meet their own demands. As an emerging market, it is not clear that the United States would meet the IMF requirements for borrowing, a strange concept given the extent to which it is perceived to be the safest
Think of a swamp fire, or a fire in a coal mine, where underneath the ground there is a common smoldering heat source, which every once in a while flares up to the surface where it must be put out. Firemen come in and douse it with water and fire extinguishers and that flame goes away. Six months later, it comes up again.

This is what the conditions are today in emerging markets. In Indonesia, South Korea, Thailand, Malaysia, Brazil, Russia, Mexico one after another we get a flare-up. But it is all the same thing. It is a preference for risk-averse investing. It is a preference for guaranteed returns. And it is an aversion to the downside risk of a free market that extracts a penalty for over-exuberance. We have to treat the basic fire, rather than just the flare-ups.

Each emerging market considers itself unique in attempting to solve its own problems. But the problems are quite common. In order to rebuild their economies, most emerging markets have borrowed heavily in dollars in this capital-plentiful period. Investors have also invested dollars in those economies and now plan, at higher

The Trend of Investing Mindset

The ability to move from market to market assumes that investments and their environments are disconnected, that market movements are not strongly correlated. But in these days of global banking and instant communication, that condition is less likely. Markets and investments in those markets may be increasingly synchronized.
In the past two decades, as emerging market investment grew dramatically, globalization permeated our financial systems. Now there are some clues of a cyclical return to local and national interests. If so, investments by foreigners in any market may be treated harshly.

For example, some now argue that the rapid expansion of emerging stock markets in recent years is likely to hinder rather than assist faster industrialization. According to this view, while stock markets may be potent symbols of capitalism, paradoxically, capitalism often flourishes better without their dominance. The inherent volatility and arbitrariness of stock market pricing in developing countries make it a poor guide to efficient investment allocation. Portfolio capital inflows from overseas lead to interactions between two inherently unstable markets: the stock and currency markets. Such interactions in the wake of unfavorable economic shocks may exacerbate macroeconomic instability and reduce long-term growth.

Emerging market investment depends on steadily growing liquidity to be able to pay back investors at higher levels in a foreign currency. This works when the market is going up and money is coming in. But in the reverse, liquidity is tight; the ability to pay foreign creditors is lacking and confidence plummets.

Thus, emerging market investing may be a long-term cyclical phenomenon and not a steady, one-way path to riches. Certainly, the emerging market investment phase of more than the last decade is over. Not only has capital been destroyed and confidence shattered, but the idea of capital flows for superior return from developed countries to needy, developing ones is gone. The latter do not want the funds on anything like the terms that would be required.

A common theme of this book is that investment success is most often observed where the market requirements and investor personality are one. The old shibboleth that "investors don't pick markets, markets pick investors" is more true in emerging markets than elsewhere. And Mark Mobius's style, hard work and tough mind are exactly what was needed in emerging markets. These markets may undergo a change. Will he?

Five Central Investment Attitudes

Diversification: this is particularly important in emerging markets where individual country or company risks can be extreme. Global investing is always superior to investing solely on the investor's home market or one market. Searching world-wide leads an investor to find more bargains and better bargains than by studying only one nation.

Timing and staying invested: as Sir John Templeton says, "the best time to invest is when you have money." In other words, equity investing is the best way to preserve value rather than leaving money in a bank account. As a corollary, an investment should not be sold unless a much better investment has been found to replace it.

Long-term view: by looking at the long-term growth and prospects of companies and countries, particularly those stocks that are out of favor or unpopular, the chances of obtaining a superior return are much greater.

Investment averaging: investors who establish a program from the very beginning to purchase shares over a set period of intervals have the opportunity to purchase at not only high prices, but also low prices, bringing their average cost down.

Accepting market cycles: any study of stock markets around the world will show that bear or bull markets have always been temporary. It is clear that markets do have cyclical behavior with pessimistic, skeptical, optimistic, euphoric, panic and depressive phases (see Manias, Panics and Crashes). Investors should thus expect such variations and plan accordingly.

In assessing emerging market investments, Mobius stresses the importance of constantly being aware of influences and biases. These are strongest in the places where you spend most of your working and leisure hours and from where you obtain most information. For this reason, the emerging market investor must continually visit all the countries in the emerging market areas and read news and research reports originating from all over the world. (However, as a counterpoint, the internet now makes available a wealth of information on individual markets and countries perhaps better and less costly in time and effort than that obtainable on the ground.)