Emerging markets are assuming an ever more prominent role in the global economy and in investment portfolios. As they do, they seem to be increasingly difficult to figure out. Some portfolio managers and strategists view emerging markets as high-risk assets in countries whose economies and businesses are highly leveraged to, and dependent on, global growth. According to this view, they are like any other stock market, only more so.
Another school of thought, which has been catching on in the last two or three years, holds that emerging markets are among the safer destinations for investors' money. The developing world has evolved from a collection of debt-addled command economies ruled capriciously and ineptly by El Presidente or the Politburo, adherents of this idea contend, into hotbeds of commercial enterprise with huge trade surpluses and foreign reserves, as well as benign and often wise leaders.
Each camp has points in its favour. When the financial world began to fall apart two years ago, the focal points of the crisis were banks in the US and Europe, not Asia and Latin America, as in previous tumultuous times. When the credit crunch caused growth to slow or vanish, it was the developing economies that were better able to cope. They had the cash on hand, and they didn't need as much as the West did to shore up financial institutions. While some European countries continue to struggle, such as Greece and Iceland, those in the emerging world appear to be enjoying a much smoother ride, with the notable and local exception of Dubai.
All that's as may be, old-school observers would say, but it was still the developing stock markets that suffered the most during the crisis as investors fled risk. They are also the ones enjoying the greatest rebound as risk-seeking has returned to fashion. Reconciling these antithetical views and circumstances isn't easy, but analysts at Barclays Capital make a fair go of it. They have selected 10 countries that they place into a new category, Advanced Emerging Markets, that serves as a way station between emerging and mature.
The point of the exercise, they say in a recent report, is to "capture a list of countries with a future of solid growth without the volatility ... characteristic of the original emerging market countries." The factors used to make their choices include financial and economic stability, a history of healthy growth, and an improving government policy backdrop, including a strong response to the recent global crisis. The analysts emphasise that they are interested in consistent and persistent development.
"Because our goal is to identify countries that have graduated from the traditional emerging market predicaments in a permanent way, the criteria should capture long-standing progress on each of the relevant fronts, rather than the latest economic miracle," they explain. The 10 that fit the bill, ranked from the best down, are: Singapore, Chile, Korea, Taiwan, Israel, China, Brazil, South Africa, Poland and the Czech Republic.
It's certainly a geographically broad collection, although investors in the Gulf will note that their markets are shut out. This seems to be a matter of quantity, not quality. "All else being equal, bigger countries normally capture more attention than smaller ones, as they are likely to have a more important global impact, as well as deeper financial markets," the report states. Fair point. That suggests that such developments as the wider opening of Saudi Arabia to foreigners and the consummation of plans to introduce a Gulf Co-operation Council currency would be good for markets.
Without them, conversely, Gulf markets will have trouble attracting foreign money, which could keep valuations lower than larger markets with the same economic fundamentals. As for the markets that do make the Barclays Capital list, a few raise eyebrows. China has navigated the financial crisis well, but the country is not exactly the poster child for free markets. It may be included in part because it's too big to be left off.
Poland and the Czech Republic aren't paragons of fiscal rectitude and seem to be odd fits with the analysts' standards for economies on the cusp of maturity. But they do rank ninth and 10th, which makes you wonder what locale finished 11th. The list and the analysis that produced it also fail to acknowledge that despite the advances in emerging economies like these their bourses continue to undergo far more violent swings than those in economies recognised as developed. Investors apparently haven't reached the same conclusion as Barclays.
There is a way to take advantage of the discrepancy. The next time the broad class of emerging markets skyrockets (perhaps that time is now), lighten up on positions in markets that are conspicuously unlike those that Barclays highlights. When emerging markets plummet, as they did in 2008 and will certainly do again, use the list as a tour guide for a bargain-hunting expedition. Conrad de Aenlle writes from Los Angeles about investment and personal finance issues. His blog on contrarian investing for MoneyWatch.com, "Against the Grain," can be found at http://bit.ly/NjaBa