Why We Should Stay Away from Emerging Markets

Tahsanul Hoque, Guest post - The Asif Khan BlogTahsanul Hoque is currently working in Internal Accounts Payable in Morgan Stanley. He is a postgraduate of Ohio State University in Finance and a graduate of North South University. Even though he is a banker by profession he is also an avid investor by choice.

 

Most global stock investors are now well familiar with how their investments started 2014 after a phenomenal bull market of 2013. With US Fed taper in the horizon forcing a currency crisis in some emerging economies and S&P 500 going down by nearly 6% at peak, you must be wondering what you should do with your investment portfolio. You must be wondering that the good things have to come to an end at some point, right?

I have recently advised a strategy in my blog regarding why you should remain in US capital markets for now.  But what should you do if you are thinking about putting more money in emerging markets? You may think this is the good time to buy emerging stocks, since they are now very cheap. Emerging markets after all the big buzzwords on everybody’s lips. While on technical terms they are now cheaper compared to other major global stock indices, you should avoid investing in them unless you are a short term trader.

Under performance of EM even during the supposedly golden times

Let’s look at some popular Exchange Traded Funds on emerging market stocks in Wall Street and Europe and their performance over last 5 years.

 Exchange Traded Funds on emerging market stocks in Wall Street and Europe and their performance over last 5 years.
Google Finance
 Exchange Traded Funds on emerging market stocks in Wall Street and Europe and their performance over last 5 years.
Google Finance

Now you do not need a Bachelors in Finance or Economics to notice the general trend of these investment performance since 2010 (2009 was the only year where they performed well in these graphs). In most cases, the long term investor did not see any gains by investing in broad based emerging market funds. It seems to be they are in a slow bear market since middle of 2011. (Mainly due to unfavorable currency conversion issues with these investments)

Further federal reserve tapering on the cards

Remember the big picture in these graphs is that US Federal Reserve did not yet begin their tapering on full fledge. Instead the hot money from Quantitative Easing have been pouring into these investments during this timeframe. The slow tapering has just started for 2 months. Do you think the emerging market funds can manage to gain with Federal Reserve slowly withdrawing their stimulus? Think again. Your money is better invested somewhere else.

Chinese entrepreneurs diversifying outside China is a leading indicator

On the other hand, rich Chinese entrepreneurs are hastily trying to make other countries their second home. This is a subjective issue but sometimes these give some indications.

It does not take too long to notice these emerging markets have structural problems that need to be corrected by their government. So till then, it is better to avoid them.

What should we do?

Instead invest heavily more in US markets or frontier markets. Even though they also face headwinds from Fed tapering, the underlying short and medium term fundamentals are good enough to support these stocks. See these funds and their performance.

Instead invest heavily more in US markets or frontier markets. -The Asif Khan Blog
Google Finance

I still believe that over the very long run, emerging markets will be the leader in global investments. Ultimately the developed countries and their insatiable appetite for debt is not sustainable in the very long run and this will lead to major de-leveraging. However, as long as emerging economies do not increase their domestic consumption, as long as they remain export focused only with developed countries, I do not see them growing to be a major leader too soon. It will happen ultimately but not in the near future that is for sure. So for now avoid these markets. But if you are still a believer in Emerging markets for short to medium term horizon, I suggest you look at Emerging market Technology ETFs (such as CQQQ)

Disclosure: Please take your investment decision with your own knowledge and analysis. The analysis given is the author’s own independent view.

5 thoughts on “Why We Should Stay Away from Emerging Markets

  1. Well I think the growth in emerging markets was partly a result of loose monetary policies of the US. And I don’t know why people are making a big fuss about the tapering. I mean, the Fed is only tapering because the US economy is coming back on track. It cannot be solely blamed for the crisis in the EM because, let’s face it, the tapering is only accelerating the inevitable. As one analyst puts it – the era of cheap money is over.

    Goldman Sachs warned about investing in Emerging Markets now. Even Marc Faber said it was ‘too early to commit to Emerging Markets’. Here, I would adopt to Ruchir Sharma’s views that investors should focus on individual countries instead of the emerging markets as a whole. So instead of buying into EM ETFs, I think it would be better if investors focus on individual constituent companies in the ETF. I think it’s also better because in most of the EM ETFs, the top 4 countries have a combined weightage of over 55%. So an investor buying these ETFs will inevitably have exposure to countries like China, SK and Brazil.

    However, I think the ultimate question is whether the USA would be the destination for money flown of from Emerging Markets.

    1. You are right that one of the way to mitigate this risk is to invest in select emerging countries instead of investing in broad ETFs but for many investors, that will not be easy. You need to go into mutual funds or hedge funds and those have higher fees so the net return has to be considered.

      Also most of the funds are now flowing into US now. Check this article.

      http://www.reuters.com/article/2014/02/21/us-investing-fundflows-bofa-idUSBREA1K14C20140221

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