Emerging Markets, Submerging Markets
We have noted the steady ascent in the respectability of "emerging" markets over the past several years। Indeed, our impressionistic sense is that the status of this investment sector is gaining luster at an accelerating pace. Today, "emerging markets," which was a category historically relegated to the margins of invisibility by investment pattern-setters in the U.S., have made it to prime time. Not only is there an abundance of printed and visual media attention to this investment realm, but there has been an official anointment by Wall Street. Individual and institutional investors MUST now have an "emerging market" allocation. These markets, Wall Street opiniom-makers and investment houses now solemnly intone, have much faster growth, more dynamic economics, and more rewarding markets, than the "helpless, pitiful giant" of the U.S. market, to employ Nixonian rhetoric of yore.
We have no quarrel with the notion that selected foreign economies will likely grow much faster than the American economy for quite some time to come. Nor do we doubt that, over the famous "long haul" some of these markets will perform very well. However, it would be well to bear in mind that the long-run consists of a succession of short-runs. In volatile and unsophisticated "emerging" markets, which are dominated even more by herd emotion than is our own herdy market, certain "short-runs" could consist of cyclical bear markets of 50-70%. For those who wish to speculate in these markets, it will be necessary to either be skilful at market timing, or else have a steel stomach, bottomless pockets, and an unshakable long-term perspective a la Buffett.
Since few investors possess these attributes, it would be well to be attentive to warning signs। The popularity -- and respectability -- of "emerging markets" has risen in tandem with prices. This is normal. Enthusiasm grows as the market rises, generally reaching its greatest intensity at the very top and point of reversal. In other words, the rise in enthusiasm is a farily reliable yellow light once it passes a certain level. While it is true that a market can keep surging through a series of yellow lights, the ultimate red light ahead comes closer and closer. One has only to recall the tek stock mania, the residential real estate/mortgage mania, the Japanese equity and real estate mania, and countless others.
The emerging markets were ignored when they were dirt cheap -- when stock valuations were only a fraction of US equity valuations. They were hated after the crash of 1998-1999.
Today, some emerging markets sell at HIGHER valuations than the US stock market. Yes, there is greater growth. But there is also GREATER RISK. MUCH GREATER RISK, in many cases. These risks are military, political, accounting, corruption, weakly-based and indifferently protected business practices. There are serious defects in "transparency," as they say. All too often, investors are buying a pig in a poke.
Above all, it is the growing popularity and respectability of these markets which gives cause for concern। The cyclical top, we suspect, is a lot closer than a bottom. There is simply too much of that warm, fuzzy feeling for our liking.
We find it curious that today, when large capitalization US stocks are selling at the LOWEST ABSOLUTE VALUATIONS in well over a decade, and at extremely attractive valuations RELATIVE to current -- and to prospective -- interest rates, they are at a low level of popularity compared to richly valued "emerging" markets। Moreover, American interest rates are in the DOWN-CYCLE, A FACTOR of DECISIVE IMPORTANCE for future equity price levels. Many "emerging" markets, in CONTRAST, are facing powerful headwinds in the form of RISING INTEREST RATES.
We suspect that this "conundrum" -- to quote a very eminent former central banker -- will find resolution in a revaluation upward of American stocks and a downward revaluation of "emerging markets." While this may not occur for a while, the PRUDENT course of action is clear, we think.
