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Monday, October 6, 2008

Opportunity in Emerging Markets Amidst This Panic

September was one of the worst months on record for individual and professional investors alike. By the end of the first week in October, stocks dropped to new bear market lows and credit markets remained in a state of disorder, despite Friday's passage of the Treasury's bailout package.

Current panic conditions present an opportunity to increase our exposure to equities. We are establishing a 4% position in the Vanguard Emerging Markets ETF (VWO) in our Conservative Growth portfolio, and increasing our exposure from 5% to 8% in our Moderate Growth and Aggressive Growth Portfolios.

Buying never feels comfortable in conditions such as these, but that is precisely how good investors are rewarded over time - by having the conviction to increase exposure when everyone is running for the exits late in a bear market, and reduce exposure when everyone is aggressively taking on risk late in bull markets.

We believe that we are at or near a panic bottom in global equity markets, and that the recent dramatic sell-off has created a good buying opportunity in stocks, and particularly emerging markets stocks. Emerging markets stocks, as defined by the MSCI Emerging Markets Index (the index VWO tracks), are down 48% from their peak, versus a 30% peak-to-trough decline in U.S. stocks. At current prices, the MSCI Emerging Markets index is valued at just over 10 times trailing earnings. Unlike the U.S., Europe, and Japan, emerging economies are not in recession, and are in fact continuing to grow at a healthy pace. The IMF estimates that GDP growth in the developing world will be 7% in 2008. Relative to their growth prospects, which are much superior to those of developed economies, emerging markets appear particularly attractively valued at this time.

We would add the following points about emerging markets:

1. Emerging markets stocks currently account for 11% of the world's stock market value, so an investor who wished to construct an equity portfolio that resembled the world's market capitalization would give an 11% equity weighting to emerging markets. Emerging markets account for 30% of global GDP, so one could make a strong argument that the equity portfolio weighting could be even higher.

2. Emerging countries are home to 85% of the world's population and 75% of the world's natural resources. Approximately 70% of the world's GDP growth over the next two decades is expected to come from emerging markets.

3. Emerging markets are not as exposed as developed markets to the bursting of the credit bubble because they have not been nearly as reliant on credit growth - at the household, government and corporate levels - to fuel their growth in recent years. Financially, emerging markets are creditors to the global economy, collectively amassing huge annual current account surpluses and controlling three quarters of the world's foreign exchange reserves.

On a final note, we think the current hysterical fear-mongering among the news media and politicians about the prospect of another Great Depression is overblown, ridiculous and irresponsible. Yes, we have paid and will continue to pay a heavy price for our financial excesses, but the idea that the economy is entering a state anywhere close to the Great Depression is absurd. Keep in mind that virtually all of these people now proclaiming that the world's economy and financial markets are plunging into the abyss were either oblivious or complacent about the problems that led us into this crisis.

Historically speaking, it's usually the universal recognition of recession and bear markets, accompanied by the dire headlines that things could get far worse, and the resulting investor fear and panic that often creates the final market bottom. It is entirely possible that markets, which are a manifestation of mass psychology, are today discounting the worst-case scenario. It is not out of the realm of possibility that this could turn into a once-in-a-century financial and economic Armageddon like the 1930s, but that outcome is extremely unlikely.



Seven Star Hand said...


One must understand the truth before any true solutions are possible. There's much more to this unfolding story than meets the eye. Suppress the urge to scoff and write me off. Be a little patient to understand the truth and then hold their feet to the fire!

Here is Wisdom...


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