The past five years in the U.S. stock market have been like an all-expense-paid trip to the South Pacific. By raft.
If you’re thinking of sending your money to exotic locales — Latin America, Eastern Europe or Asia — it may be a profitable trip. The trick is coming home before you get set adrift.
Emerging markets funds have gained 12.4 percent this year, vs. 1 percent for the becalmed S&P’s 500-stock index. These funds invest in stocks of companies headquartered in smaller, less-developed countries, such as Brazil, Singapore or Poland.
Those gains mask some of the astonishing gains emerging markets have had this year:
- Egypt, up 86 percent, says Morgan Stanley Capital International, which tracks foreign markets.
- Colombia, up 43 percent.
- Hungary, up 42 percent.
Rising commodity prices are one reason for the run-up in emerging markets. The Commodity Research Bureau Index, which measures the performance of commodities, has gained more than 12 percent this year. Oil has rocketed from $43.45 a barrel at the end of 2004 to $67.49 now.
Not surprisingly, countries that are big commodities exporters have seen their markets surge. Saudi Arabia’s market, for example, has soared 81 percent, according to Bloomberg Business News. Argentina has gained 47 percent; Russia is up 34 percent.
But commodities aren’t the only reason that emerging markets have fared well. “It’s really a change in the macroeconomic environment,” says Mark Mobius, emerging markets manager for the Franklin Templeton Investment Funds. Emerging markets collapsed spectacularly in 1998, when Thailand and other Asian countries devalued their currencies. The average emerging markets fund fell 26 percent in 1998, fund tracker Morningstar says. ING Russia Fund plunged 83 percent.
Since then, many developing countries have pulled themselves together, balancing their budgets and improving their balance of trade. Furthermore, firms based in emerging markets have been paying down debt and paying out dividends, Mobius says. As a result, some countries that are net commodity importers, such as South Korea and China, have fared well.
By cleaning up their acts, these countries have gotten two additional bonuses. First, it lets them borrow money at cheaper rates, just as an individual with a good credit rating can get a better rate on an auto loan.
During the 1998 debacle, emerging market debt yielded 17 percentage points more than comparable U.S. Treasury securities. It’s down to 3 percentage points above Treasuries now, says Matt Ryan, manager of MFS Emerging Market Debt Fund.
Their currencies have grown stronger, too, and that gives a boost to U.S. investors. For example, the Brazilian stock market has gained 7.6 percent in its own currency, the real. Translated into U.S. dollars, the Brazilian market jumped 18.4 percent. Similarly, the Mexican market gained 14.4 percent in pesos, but 17.1 percent in U.S. dollars.
How does that work? Suppose you buy 10,000 Mexican pesos for 9 cents apiece. Six months later, the dollar has fallen in value. It now takes 11 cents to buy a peso. You can exchange your pesos for $1,100 — a $200 profit. Had the peso fallen, however, you’d have lost money.
Here’s the problem with emerging markets funds: When they run into a storm, they sink faster than you can say, “Titanic.” In general, you can expect much higher highs and lower lows from an emerging markets fund than, say, one that follows the S&P 500. Consider the Lipper Emerging Markets Funds Index, which tracks the largest emerging markets funds. The past 10 years, the index’s worst one-year performance was a 49 percent loss, vs. 27 percent for the S&P 500.
In short, timing counts a great deal when you invest in emerging markets. Indexes are typically begun at the height of a sector’s popularity, and Lipper’s Emerging Market Index is no different. The index has gained an average of just 3.3 percent since its inception in 1994. Had you invested at the end of August 1998, when the emerging markets currency crisis was at its worst, you’d have gained an average 16.4 percent a year.
Emerging markets have a low correlation with the U.S. stock markets, which makes them a decent way to diversify. Moderation is the key: 5 percent to 10 percent of your portfolio is plenty for investors. Otherwise, you might be better off with an emerging markets bond fund — or keeping your money at home.
By John Waggoner
Contact John Waggoner at jwaggoner@usatoday.com.
Source: Delaware Online
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