Tuesday, October 5, 2010

The last great hope: Emerging markets may be the next bubble

"Energing market speculation tends to appear at a juncture in the economic cycle when 
declining yields on domestic bonds combine with an excess of capital to make 
foreign investments particularly attractive."
-Edward Chancellor
Chapter 4, Fool's Gold: The Emerging Markets of the 1820's
Last seen in  "Citi: Americans Have Just Added More Money To Emerging Markets Than They Did From 1995 - 2005".

From the Economist's Buttonwood blog:
THE internet allowed people to pay lower prices for books but also encouraged them to pay stratospheric prices for shares in lossmaking dotcom companies. During the subprime boom Americans believed the illusion that they could get rich by buying each other’s houses.

Those dreams may have been shattered. But hope springs eternal. There is still one great hope left for investors: emerging markets. Fund managers have been making the case for emerging markets on a regular basis over the past 20 years. Developing countries offer higher economic-growth rates, have younger, more dynamic populations and are under-represented in the global stockmarket. Buying a stake in emerging markets is like buying a stake in the future.

Goldman Sachs, for example, reckons that the total capitalisation of emerging markets will rise from $14 trillion today to $80 trillion by 2030, increasing from 31% of the global total to 55% in the process. Even allowing for new equity issuance, that will still translate into an annualised return of 9.3%, Goldman estimates, compared with just 4% for developed markets. It seems like a no-brainer.

But experience should teach investors to be suspicious of no-brainer decisions. The same arguments were advanced in the early 1990s, after all. But between 1991 and 2000 emerging markets delivered a total return of just 38% and developed markets returned 171%. Outperformance came only in the decade just gone, with emerging markets almost quadrupling investors’ capital since the end of 2000.

A caveat also needs to be applied to the growth case. Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School examined their database of 17 national stockmarkets since 1900. Using a variety of tests, they found virtually no correlation between an individual country’s GDP growth rate per head and the returns to investors.

What is the explanation for this rather counter-intuitive result? One answer is that a stockmarket is not a perfect facsimile of an economy. Many companies are unquoted. Those businesses that have floated on the market may be mature, or slower-growing, or simply overweight in one sector. In 1900 Wall Street was dominated by railroad stocks, for example....MORE
From the Richter Scales: