Emerging market stocks have been hammered this year as the US and Europe have enjoyed one of the best stock markets in history. Why? What happened to the argument that slow (GDP) growth in the developed world and much higher (GDP) growth in the emerging economies argued in favor of a heavy commitment of investment funds to emerging market?
As it turns out, emerging market economic growth has, indeed, been much, much higher than economic growth in the Western nations. So, why did their stock markets put in such a pitiful performance thus far this year? A similar pattern occurred in US history when foreign investors, mostly British and Russian investors, lost bucketloads of money betting on growth in the US economy in the 19th century. This is not the first time that dramatic GDP growth failed to help investors in public stocks.
Many of the most vibrant companies in the countries that fall into the 'emerging market' category are not public companies. They are privately owned companies that aren't included in any of the emerging market portfolios that you and I can own. Instead, roughly 40 percent of the capitalization of 'emerging market' ETFs are typically government-owned or heavily regulated companies, such as the local telephone company or local utility company. Are these good investment bets in a third world political environment?
If emerging markets boom, you are much more likely to make money owning Coca Cola stock than the stock in the local telephone company in Egypt or Venezuela. The inherent logic behind huge investments in emerging markets never made any sense in the first place.
That said, it may now be time to buy the emerging markets, since everyone seems to be abandoning them in a rush. India's stock market lost four percent of its value in a single day at the end of last week.
It may be time to take another look at emerging markets, now that their staunchest supporters seem to be running for the exits. But, one should be cautious. Emerging markets involve stocks that have fundamentally different characteristics and corporate governance rules than Western investors may be accustomed to.