By Steve Tepper, CFP®, MBA
You’d have to be a little crazy to invest in emerging markets right now. There are so many problems in the second and third world, they could hardly all be listed in this short article. But here are a few key drivers of expected weakness outside of the U.S. and developed international markets:
- Cooling off of China. Annual GDP increases of 8% to 14% in China made emerging market funds winners in the mid to late 2000s, but the country’s recent numbers and forecast are not as rosy.
- Fear of rising interest rates, which restricts the flow of money to non-developed markets.
- Plummeting commodities prices—in particular, oil—have hurt third world countries whose natural resources are often their most valuable currency.
- Anti-globalist sentiment across Europe, particularly in the U.K., have raised concerns about investing in developing markets.
- And Putin. What’s up with Putin? The Russian president has single-handedly provoked political turmoil not only in emerging economies like Ukraine and Turkey but in Brazil, South Korea, and the U.S. as well.
Most of these factors have been simmering for months or years, with one more added to the mix last year: The U.S. presidential election campaign, in which the candidate who would eventually win marshaled the forces of anti-globalization from both the right and the left. Every sign pointed to one outcome: Emerging markets were going to get crushed.
You know where I’m going with this, don’t you? As I’m writing this in late June, the MSCI emerging markets index is up almost 19% year-to-date (after gaining more than 11% last year).
So it’s no wonder we’re a little crazy, because we are invested in emerging markets and have never gotten out. We didn’t get out in 2008 when the same MSCI index fell more than 50%, and good thing, because it ran up nearly 80% the next year.
As you can see from Table 1 below, we had a run of good years leading up to the 2008 crash, a big recovery in 2009, and then spotty performance. Even so, it has been a winning asset class, weathering economic and political storms, and providing an annualized return of 11.2% for the last 14-plus years. That’s good enough to turn a $1,000 initial investment into nearly $5,000.
MSCI Emerging Markets
Annual Performance (%)
So why the unexpected results this year, after a tirade of bad news or ominous warnings? As bad as the financial media and economists seem to be at predicting the future, they seem to also struggle with playing “Monday Morning Quarterback,” offering up many, and sometimes conflicting, reasons for why things happened that shouldn’t happen. Here are a few of the postmortem excuses offered from the press:
- The market decided Donald Trump was more talk than action on trade. For example, after the election, he backed off his campaign rhetoric that China was a currency manipulator.
- After years of bad news and sluggish performance from 2011 through 2015, emerging market stocks were undervalued and therefore poised to rally.
- Emerging markets are not as risky as they were just a few years ago. The most in-debt countries had deficits totaling around $300 billion in 2012. Today that number is below $100 billion.
- Economists believe there is less risk that the dollar will rise. If it did, it would raise the debt service cost for debtor nations. Conversely, emerging market currencies have been strengthening, which has the opposite effect, making their debt service easier to handle.
All of these seemingly logical but ultimately incorrect predictions and rearview reassessments serve as reminders that even the so-called market experts can’t be relied upon to provide meaningful information to help us time the market or any segment of the market. And so we remain committed to broad investment across many asset classes, no matter what the prognosticators say.
Source: Bounce Back by Eric Rasmussen, Financial Advisor magazine, June 2017.
Past performance is no guarantee of future results. There is no guarantee an investment strategy will be successful. Diversification does not eliminate the risk of market loss. Investing risks include loss of principal and fluctuating value. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks.