Hit by BRICs
By now, most investors have had the message pounded into their heads. Want superior growth? Buy Emerging Markets. The higher-growth economies of Brazil, Russia, India and China, (BRICs), et al will produce higher long-term returns. And because their markets might zig (a technical term) when Emerged Markets (yes I made that one up)-like the U.S.-zag (another technical term) the result is higher returns and lower volatility. Right?
Well, yes and no. True, the returns are higher. The MSCI Emerging Markets Index has returned around 11% over the past quarter century, while the S&P 500 has earned around 10% over the same period. I'll be the first to admit this seemingly small 1% annual advantage produces 25% more dollars (or rubles, pesos, yuan or rupees) over the 25 years. Assuming you, Mr. or Mrs. Thrillseeker, hung on for the 25 year roller-coaster ride.
That's because Emerging Markets have exhibited a tendency to decline big-time (also a technical term) when our markets drop big-time, negating some of the diversification benefits. During 2000-01 and 2008-09 when U.S. markets declined roughly 50%, the MSCI Emerging Markets index did the same. Not much diversification benefit, when your stomach needs it most. Creating further peril, extreme volatility often leads to fear-based selling by the Thrillseeker family during major declines, making it very likely the average investor earns far less than the index return.
Now that I've whetted your appetite for foreign markets, let's take the pulse of Emerging Markets today.
First up, China's economy is slowing, as a lending and borrowing boom that fueled a real estate, capital investment and export party is fizzling. Meanwhile, the autocrats in charge are searching for the next stimulus to reignite growth and maintain social order among 1.3 billion aspiring citizens. Brazil is suffering a hangover from China's slowdown, as its export-dependent economy is no longer feasting on high commodity prices.
How about Russia? After Vladimir finishes the hostile takeover of Crimea, Russia will be in the economic sanctions penalty box for quite a while. Investors are already yanking their money and going elsewhere. India is a perennial "show-me" economy, long on promise and short on results. Corruption, bureaucracy, stifled trade policies and a lack of foreign competition leads to weaker growth and higher inflation. India needs fewer bureaucrats and more investment.
The pain doesn't stop there. South Africa has political problems and slower growth. But wait, there's more. Ongoing demonstrations in Turkey. Militant attacks in Nigeria. And of course, the Middle East has its longstanding problems-Iran, Iraq, Syria-need I say more? Argentina and Venezuela suffer from populist policies-"give the citizens what they want now, we'll worry about the long-term consequences later, like when we're not around". Did I miss anyone? Oh, yeah, I did. Indonesia and Thailand are dealing with growing unrest, demonstrations and sluggish growth.
Actually, there are plenty more examples, but you get the point. Many parts of the Emerging World are still emerging, and democracy, the rule of law, free trade and free markets are still ideas. Bad stuff happens. Demonstrations, riots, wars, coups, invasions, insurgencies, expropriations, secessions, recessions, depressions, inflation, deflation, currency devaluations-you name it, and many parts of the emerging world eventually experience some or all of it.
The next decade for Emerging Market economies and investors is likely to look different than the past 10 years. And not in a good way. After booming, they'll probably see slower growth and occasional political turmoil while needing to spend vast sums to improve living standards and deal with ever-increasing populations. A tougher environment.
Given this, why invest in Emerging Markets? Good question. I don't have a good answer. We stick to what we know, which for us is mostly found here in the U.S. of A. We believe that higher growth doesn't necessarily translate into correspondingly higher stock market returns.
You should thoroughly understand the pros and cons of whatever you invest in. Especially if you are investing in Emerging Markets, expect to stay put for a while, through the downturns and periodic upheavals. Buy during downturns, and lighten up during periods of exuberance. Yes, you read that right. If you can't do all this, your investment portfolio might feel like it was hit by a pile of BRICs.
-John Heldman, CFA