February 26, 2011
Suddenly, Emerging Markets Look Complicated Again
By PAUL J. LIM
LATE last year, when demand for emerging-market stocks reached new heights, investors viewed the threat of global inflation as yet another reason to keep betting on them.
That’s because the fortunes of many companies based in fast-developing regions like Asia and Latin America are linked to commodity production, which stands to benefit when inflation rises. That would explain why nearly three-quarters of professional money managers surveyed by Russell Investments late last year described themselves as “bullish” on emerging-market equities, even as inflation worries began to climb.
Yet after the first real signs of inflation surfaced this year — in January, consumer prices in Europe and core wholesale prices in the United States both climbed to their highest level in two years — emerging-market stocks experienced their first real setback since the global financial panic of 2008. The average mutual fund that invests in a diversified basket of emerging-market shares has lost nearly 6 percent of its value so far this year, according to Morningstar. The Standard & Poor’s 500 index of domestic stocks, meanwhile, has climbed by 5 percent.
This development would seem to underscore the growing complexity of investing in emerging markets — as well as their growing risks, strategists say.
On the one hand, the poor performance of these markets reflects a simple fact: Many developing markets have become a victim of their recent success.
Robert C. Doll, global chief investment officer for equities at BlackRock, the investment manager, noted in a recent report that while growth had stalled in many parts of the developed world, emerging economies “continued to grow during the global recession and are now getting an additional growth jolt as the global recovery gains traction.”
As a result, central banks in many of those regions have had to start raising interest rates in an effort to curb inflationary pressures — which were brought about by that growth.
China is an example. In an attempt to keep a lid on food costs and other prices, the People’s Bank of China raised key short-term lending rates three times in the last four months.
That, in turn, has held down stock prices there: Chinese equities are down roughly 5 percent so far this year. Mr. Doll noted that even though tightened monetary policies in the emerging markets had temporarily depressed stock prices, economic activity in those regions had stayed strong.
According to IHS Global Insight, China’s economy is expected to expand three times faster than that of the United States this year. This would suggest that “further tightening is likely” throughout the emerging markets,” Mr. Doll said.
To be sure, some developing markets that are big commodity producers are benefiting from rising prices. Russia’s stock market, for example, has appreciated by more than 18 percent over the last three months as oil prices have shot to nearly $100 a barrel.
But rising fuel costs have added to food inflation throughout the world, which “can also lead to unrest in emerging markets where they spend a much higher percentage of their income on food than in developed nations,” said Jeffrey N. Kleintop, chief market strategist at LPL Financial in Boston. The potential for turmoil was underlined last week as growing unrest in the Middle East spread to oil-rich Libya, helping oil prices to hit a new two-year high.
That growing instability served as a “stark reminder of the political risks in the emerging markets,” said Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago.
Mr. Ablin noted that so far this year, investors have not been rewarded for exposure to greater political risks abroad.
THAT explains why a torrent of money has been fleeing the emerging markets of late. A survey by Bank of America Merrill Lynch found that only 5 percent of professional fund managers were “overweight” on emerging-market stocks in February, meaning they held a greater stake in such shares than their investment strategy would normally call for. In January, that figure stood as high as 43 percent.
Of course, it’s possible that the recent troubles in emerging-market stocks may eventually turn into a buying opportunity. But these stocks have trounced domestic equities for 15 years, so it may take a lot longer for prices to reset to attractive levels.
Paul J. Lim is a senior editor at Money magazine. E-mail: firstname.lastname@example.org.